Author Topic: Inflation & Interest Rates: share your data sources, models, and assumptions  (Read 134012 times)

MustacheAndaHalf

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At the start of 2021 I though equities were going to have a difficult year, putting in a major top at some point during the year and then beginning a significant period of correction... it looks like I was about 6-8 months early, but that seems to be what is happening now.

I don't think there's really anything to be done at this stage.  No one should be making any knee jerk changes to their their long term strategy just because of a difficult year - the difficult periods are a necessary part of the cycle which ensures capital is allocated in the right hands to enable the long term upward progression.
I don't mean to put you on the defensive, but I am curious to read what you said about 2022 back in Dec 2021.  Personally, I can't point to posts of my own - I was taking a break from the forum for a couple months.  But I sold off my crypto and leverage (call options) in late Dec up to Jan 5.  I thought we'd have a more volatile year than average.

You said "part of the cycle which ensures capital is allocated in the right hands", which sounds like the description of a bear market.  Bear markets destroy companies that can't survive.  The companies in ARKK are especially at risk, since many have no profits and may be unable to raise capital.  That type of stock, in general, may go bankrupt during the next bear market.

Personally, I think we're in for a bear market.  Right now the S&P 500 is down -3.5% over the past 12 months, which I think has lulled people into thinking they'll see a repeat of 2018 or 2020.  The business cycle, in my opinion, will not be denied.

The Fed can always decide they will delay the next bear market.  They did that in 2018, switching from QT to QE.  The U.S. economy required help in 2020 from both Congress and the Fed.  But now... will the Fed save the stock market again?

habanero

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The US rates market is now pricing around 1/3 probability for a 75% hike next week (post CPI figs obv). But its very voltile so the exact percentage varies quite a bit depending on when you look at it.

ChpBstrd

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I don't have a crystal ball, but I expect 0.50% at every FOMC meeting until things tame down combined with QT.

We've never seen this combination of high inflation and ultra low rates. It isn't clear if a 3.5% Fed funds rate will be enough to squash it or if we will need to go to 10.8%.

I agree, but given the inefficacy of stimulus removal and minor rate hikes, the most optimistic estimate I can possibly imagine for when things could possibly "tame down" is sometime in the first half of 2023, with the FFR topping out well over 5%. If that's the case, then the S&P500's PE's need to fall to about 15 at most (EY of 1/15 or 6.7%), and stock prices could fall further than that if there is a recession. I also don't see any scenario where rates go from 0.25% to 5% within 2 years and a recession fails to happen. What would be required for that to happen? Helicopter money stimulus at the same time we raise rates?

So why not YOLO into SQQQ call options or ZROZ bear spreads? Seriously. Somebody talk me out of it.

Inflation could still fall from today's high levels to "neutral" and we could be back to worrying about deflation risk within a couple of quarters. The fastest inflation has fallen by 6% since the 1950s appears to have been in August 2008 to April 2009. CPI fell by only 2% between January 2020 and April 2020. Inflation took nearly 2 years to fall by 6% from its 1980 peak, and that was amid Paul Volker's war. In an earlier era, inflation fell from 9.76% to outright deflation in 1949 (also in response to excess demand and supply chain issues) and then zoomed back up over 9% in less than a year, only to fall yet again. Basically, inflation might not be as sticky as we intuitively think. It's simply a consequence of policy.

So if we constrain the possible outcomes to only include things which happened in recent history, it would seem unlikely that inflation could fall fast enough that the rate hikes stop at the end of 2022. Even more concerning, most of those past bouts with inflation occurred with the FFR set at a higher level than inflation, and yet today we're digging out of deeply stimulative interest rates. At this pace we won't even hit "neutral" until fall. In terms of stocks, none of the recent fast-falling-inflation episodes occurred during times you'd want to be long in the market, except the early 1980s, which was such a cataclysmic time things could only go well from there.


https://fred.stlouisfed.org/graph/?g=Qqj8

habanero

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The Fed has somewhat limited power as the majority of retail borrowing (i.e. mortages) is fixed rate. Where I live (Norway) the majority (aound 90%) of all mortages are floating rate, which means that the lender can adjust the rate whenever they want with 6 weeks notice. And the few that are fixed are fixed for a short period, mostly sub 3y which is utterly bollocks - but thats a different story. In practice the adjustments happens pretty much only whenever the central bank changes the target rate. Higher interest rates obv feed through via other channels as well, but the knock-through effect is much more effective when the bulk of the borrowing is on a resettable rate.

Our central bank was cheek-in-tongue described as the most powerful in the world the other day. Obv it isnt as we are a tiny country, but it's hard to find a place where the effect of changes in the policy rate feed through to consumers quicker due to the nature of the mortgages here.

The good side is that they assume that they will need less hiking to achieve the goal, our policy rate is at 0.75% at mom so still very low.


vand

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I don't have a crystal ball, but I expect 0.50% at every FOMC meeting until things tame down combined with QT.

We've never seen this combination of high inflation and ultra low rates. It isn't clear if a 3.5% Fed funds rate will be enough to squash it or if we will need to go to 10.8%.

I agree, but given the inefficacy of stimulus removal and minor rate hikes, the most optimistic estimate I can possibly imagine for when things could possibly "tame down" is sometime in the first half of 2023, with the FFR topping out well over 5%. If that's the case, then the S&P500's PE's need to fall to about 15 at most (EY of 1/15 or 6.7%), and stock prices could fall further than that if there is a recession. I also don't see any scenario where rates go from 0.25% to 5% within 2 years and a recession fails to happen. What would be required for that to happen? Helicopter money stimulus at the same time we raise rates?

So why not YOLO into SQQQ call options or ZROZ bear spreads? Seriously. Somebody talk me out of it.

Inflation could still fall from today's high levels to "neutral" and we could be back to worrying about deflation risk within a couple of quarters. The fastest inflation has fallen by 6% since the 1950s appears to have been in August 2008 to April 2009. CPI fell by only 2% between January 2020 and April 2020. Inflation took nearly 2 years to fall by 6% from its 1980 peak, and that was amid Paul Volker's war. In an earlier era, inflation fell from 9.76% to outright deflation in 1949 (also in response to excess demand and supply chain issues) and then zoomed back up over 9% in less than a year, only to fall yet again. Basically, inflation might not be as sticky as we intuitively think. It's simply a consequence of policy.

So if we constrain the possible outcomes to only include things which happened in recent history, it would seem unlikely that inflation could fall fast enough that the rate hikes stop at the end of 2022. Even more concerning, most of those past bouts with inflation occurred with the FFR set at a higher level than inflation, and yet today we're digging out of deeply stimulative interest rates. At this pace we won't even hit "neutral" until fall. In terms of stocks, none of the recent fast-falling-inflation episodes occurred during times you'd want to be long in the market, except the early 1980s, which was such a cataclysmic time things could only go well from there.


https://fred.stlouisfed.org/graph/?g=Qqj8

What's more, look how much time the red line spent above the blue line before 2009, and how little time it has done so since then....

In theory any interest rate below the rate of inflation is a stimulatory (why would anyone keep cash if it loses purchasing power?), so it makes perfect sense that interest rates have needed to be higher than the rate of inflation in order to tame it.

If it was easy to bring inflation under control running loose monetary policy then don't you think that countries like Turkey would have had some success with it?  US economic commentators scoff at President Erdogan for keeping interest rates at what they consider stimulatory levels (15%!), but don't see a problem that the Fed is using the same playbook.. just shows you how much politics is behind policy and commentary on it
« Last Edit: June 10, 2022, 02:22:38 PM by vand »

habanero

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If it was easy to bring inflation under control running loose monetary policy then don't you think that countries like Turkey would have had some success with it?  US economic commentators scoff at President Erdogan for keeping interest rates at what they consider stimulatory levels (15%!), but don't see a problem that the Fed is using the same playbook.. just shows you how much politics is behind policy and commentary on it

My favourite is that, even after inflation startet soaring and the central banks finally acknowledged it they continue to buy bonds. They are - apparantly - able to do a complete U-turn on the policy guidance but shall by all means continue to buy assets 'cause they've said so earlier. The ECB is gonna stop July 1st, then hike 25 bps in July and hike again in Sep.

And their faith in models, prediction power and their ability to see into the future is astonishing. My personal fav is that the Fed - unable to predict inflation - thought itself able to predeict inflation as transitory.

PDXTabs

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In theory any interest rate below the rate of inflation is a stimulatory (why would anyone keep cash if it loses purchasing power?), so it makes perfect sense that interest rates have needed to be higher than the rate of inflation in order to tame it.

Was anyone holding on to a bunch of cash? I wasn't. Perhaps due to a unique situation in the world at the time we saw a lot of asset price inflation without goods inflation.

If it was easy to bring inflation under control running loose monetary policy then don't you think that countries like Turkey would have had some success with it?  US economic commentators scoff at President Erdogan for keeping interest rates at what they consider stimulatory levels (15%!), but don't see a problem that the Fed is using the same playbook.. just shows you how much politics is behind policy and commentary on it

To be fair Erdogan kept firing central bankers until he found one that would let him cut rates during this bout of inflation. We won't have that problem in the USA.

vand

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The UK's CPI print was 9.0% for May, yet I found this article in the archives from not even 1yr ago that reminds us the narrative of the time

https://news.sky.com/story/signs-that-inflation-rise-is-temporary-but-could-it-prove-sticky-12355455

"while CPI inflation rose to 2.5% in June, and is expected to rise above 3% later on this year, there are perhaps one or two signs, when you dig down into the figures themselves, that this might be temporary"


3% and done they said!! Why the f**k anyone still listens to the utter shit that the consensus forecasters spew is beyond me.

I have said before that inflation is one thing that is very very difficult to model - because it changes psychology. People behave differently and make different decisions if they think prices are going to be 15% higher next year than if they think prices are going to be 2% higher. That's why inflation is can be SO hard to control - it feeds itself.. the more inflation there is, the higher the natural path of future inflation.

habanero

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I have said before that inflation is one thing that is very very difficult to model - because it changes psychology. People behave differently and make different decisions if they think prices are going to be 15% higher next year than if they think prices are going to be 2% higher. That's why inflation is can be SO hard to control - it feeds itself.. the more inflation there is, the higher the natural path of future inflation.

Not if you're a central banker. They think they can predict it and despite the well-documented failture to do so think they can also see through it. It's very, very strange to behold. As this is a US forum it's obv tilted towards the Fed and the US but if you really want to look for aggressive back-paddeling it's hard to beat the central bank of Sweden. They prob hold the record for being most wrong in the developed world, but admittingly there is stiff competition for that title.

PDXTabs

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The UK's CPI print was 9.0% for May, yet I found this article in the archives from not even 1yr ago that reminds us the narrative of the time

https://news.sky.com/story/signs-that-inflation-rise-is-temporary-but-could-it-prove-sticky-12355455

"while CPI inflation rose to 2.5% in June, and is expected to rise above 3% later on this year, there are perhaps one or two signs, when you dig down into the figures themselves, that this might be temporary"


3% and done they said!! Why the f**k anyone still listens to the utter shit that the consensus forecasters spew is beyond me.

I have said before that inflation is one thing that is very very difficult to model - because it changes psychology. People behave differently and make different decisions if they think prices are going to be 15% higher next year than if they think prices are going to be 2% higher. That's why inflation is can be SO hard to control - it feeds itself.. the more inflation there is, the higher the natural path of future inflation.

As a slight aside, Economist: Low economic growth is a slow-burning crisis for Britain.

ChpBstrd

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In theory any interest rate below the rate of inflation is a stimulatory (why would anyone keep cash if it loses purchasing power?), so it makes perfect sense that interest rates have needed to be higher than the rate of inflation in order to tame it.

That's the theory that got a lot of portfolios demolished in 2010-2018, or at least led a lot of people to miss out on a historic and epic bull market. The FFR was below CPI for almost that entire time and yet CPI was well-behaved. On the chart, it looked like something crazy was happening that would imminently lead to inflation, but IRL there was some dis-inflationary cause out there absorbing all that QE and preventing ZIRP from pushing inflation above 2-3%.

The fact that the government was busy printing money to buy its own debt led a lot of classical economists and "Austrians" to declare hyperinflation was imminent. They even inflated a bubble in gold that eventually collapsed. They were wrong about inflation, the USD's value, stocks, and everything except how to earn clicks.

Basically, there was something wrong with their theories that led to something wrong with their forecasts that led to something wrong with their portfolios. That's why in the OP I tried to account for monetary leakage. I.e. if the US prints a dollar, and that dollar is spent on an imported product, it tends to go overseas, only to be invested back into US treasuries. It does not circulate in the economy, it does not contribute to monetary velocity, and the price-setting markets never see that dollar again once it leaves the country. Once in treasuries, that dollar might as well have ceased to exist as far as the open market is concerned, except for some interest payments and eventual redemptions. This cycle can continue as long as there is growing foreign and domestic demand for USD as a stable store of wealth among wealthy people and their corporations. Indeed, if the money supply somehow FAILED to grow by at least the trade deficit, we might have disinflation.

The US trade deficit is thus a proxy for monetary leakage and shows how massive the leak is (3.7% of GDP), but even it is incomplete. Rising wealth inequality in the US leads to more dollars piling up in investments (things rich people spend their money on) and fewer dollars chasing after goods and services in the price-setting marketplaces (things poor people spend their money on).

The GFC-era stimulus was criticized as going straight into the pockets of rich investors, banks, and corporations while offering minimal benefit to the poor and middle class, and the COVID-era stimulus corrected that deficiency by making payments directly to consumers. Of course, they blew spent the money on goods and services, so the economy roared back much more powerfully than in the post-GFC era. Those stimmie checks are still bouncing around in the economy so quickly that we're experiencing shortages of goods and services. That's why we have so much higher monetary velocity today than we did in, say, 2012 or 2013 back when people were grumbling about the "banksters" who profited from the stimulus.

The money will eventually end up in the hands of foreign vendors and wealthy people in the US. It always does. However the accumulation of wealth in these places seems to be taking a while. This lag time was probably the biggest blind spot in my model that caused me to dismiss inflation as transitory in late 2021. I assumed the stimmie checks were making it into the pockets of rich investors, executives, and Asian manufacturers faster than they actually were. Instead, Americans are trading the dollars with each other a few times in the price-setting domestic marketplace before someone buys an import and the dollars disappear from that domestic marketplace.

This model of monetary leakage explains the "conundrum" of the low-inflation, low-rates 20-teens, but we need information about how many hands, on average, a dollar has to pass through to eventually end up in treasuries. Judging by the M2 chart, money supply is flatlining, but will take at least 3-4 years of being flatlined to return to its pre-COVID trend. However, the Fed helpfully offers a "Velocity of M2" metric!

https://fred.stlouisfed.org/series/M2V

I shouldn't be as excited as I am about finding this. Ultra dorky! But I was today years old when I discovered that the velocity of money has been plummeting since the 1990s. I was also today years old when I noticed the correlation with the trade deficit.



And there's the relationship I've been proposing for a long time. The higher our trade deficit, the lower our velocity of money. When we buy imports and money leaves the US, not much of it returns to the price-setting domestic marketplace. This is why despite all efforts in the 20-teens, the Fed couldn't get monetary velocity / inflation up to safe levels. Cash was leaking out of the US like a sieve. It is doing even more so today; the average dollar only traded hands 1.12 times in the first quarter of 2022.

I've made lots of bearish / pro-inflation arguments, but this might be my best bullish / anti-inflation argument. Monetary velocity is slowing, stimulus cash is still steadily leaving US marketplaces and migrating to US treasuries even if at a less-than-immediate pace, and the only thing keeping inflation high is the excess of money (see M2) that hasn't yet leaked out of the marketplace, even if it is transacting slowly. When the last US stimmie check goes to an Asian electronics manufacturer, to be reinvested in US treasuries, inflation will collapse. Seen in this light, the 5-year and 10-year inflation breakeven rates seem more rational. Those investors can win the long game either through a nasty disinflationary recession or through monetary leakage.

ChpBstrd

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I have said before that inflation is one thing that is very very difficult to model - because it changes psychology. People behave differently and make different decisions if they think prices are going to be 15% higher next year than if they think prices are going to be 2% higher. That's why inflation is can be SO hard to control - it feeds itself.. the more inflation there is, the higher the natural path of future inflation.

Not if you're a central banker. They think they can predict it and despite the well-documented failture to do so think they can also see through it. It's very, very strange to behold. As this is a US forum it's obv tilted towards the Fed and the US but if you really want to look for aggressive back-paddeling it's hard to beat the central bank of Sweden. They prob hold the record for being most wrong in the developed world, but admittingly there is stiff competition for that title.

I think the long record of being wrong with short-term forecasts, plus the long record of the Fed being blamed for overtightening and causing recessions, equals a modern US Federal Reserve that is very hesitant to act on any emerging trend with less than a year's worth of monthly data. They want to be less reactive than they've been in the past, which is why they announced a while back that inflation might be allowed to "run hot" for a while if that's what it took to get the long run average in line. The strategy is to get well behind the trends, so they can do fewer disruptive zig zags and reversals (see the embarrassing episode of 2018) and make predictable policy based on established trends rather than statistical noise.

This sounds like a great plan on paper, and it seems especially appropriate when there are no historical parallels to recent economic events. However, being slow to react might be problematic with an inflation problem. 

This is why they didn't start QT and rate hikes late last year when inflation first exceeded 5%. They wanted more data. Then they announced a quarter-point baby rate hike would probably happen several months later, now they've essentially pre-announced the next three meetings' rate hikes and QT changes. Very. Gradual. Very. Predictable. And now markets are losing confidence in their ability to extinguish an inflation fire fast enough.

Powell might be forced into a more reactive stance soon, just as Fed chairs always are.

MustacheAndaHalf

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ChpBstrd - Has the Fed ever dumped $5 trillion into the U.S. economy, while Congress injected a similar amount?  I don't understand "M2 money supply" myself, but I notice it went practically exponential since 2020.  If you divide by something that increases dramatically, you get a flat area like the M2 ratio graphs you cite above.
https://fred.stlouisfed.org/series/M2SL

You considered putting everything in SQQQ, which lost 86% in 2020 followed by 92% in 2021.  If you get the timing wrong, you could wipe out your retirement.

I am very convinced we have a crash in 2022-2023, but I leave room for that prediction being wrong.  If the stock market fully recovers, I plan to close all my positions and get back into cash.  I won't take 86% losses, but I will take significant losses if that occurs - that's the risk.

SQQQ is a leveraged inverse ETF that tracks -3x Nasdaq (QQQ).  If you look back 1.5 years, QQQ has broken even - it has a performance of roughly +0%.  If you look at SQQQ and TQQQ, both have noticable losses.  Roughly speaking, SQQQ has lost 1/4th a year somehow... I assumed that SQQQ could fight "volatility decay" better than this, but I appear to be wrong.

Right now two of my positions (not all) are SQQQ and QQQ put options.  Paying for time value in put options makes more sense when I compare to volatility decay in SQQQ.  But markets are currently volatile, so I'm not buying more options at the moment.

For those who have mostly invested passively, and are switching to active investing, you are very likely to make a mistake at first.  That's what happened to me in March 2020 when I invested in long-term treasuries and gold to avoid the Covid crash.  I would caution towards a smaller move at first, and wait for mistakes to occur.  At that point, you will either learn from your mistakes or keep making them, which I think should help inform if that position is increased.  The more mistakes made, the greater the risk - regardless of what the investment is.

Another consideration is how much your portfolio is fighting itself.  If you hold Apple and Amazon stock while buying SQQQ, that's both long and short exposure to the same stocks.  Maybe it's more clear if I say it this way: if you put 10% in TQQQ and 10% in SQQQ, what you really have is a pool of cash on which you are paying a 1% expense ratio.
« Last Edit: June 10, 2022, 08:36:07 PM by MustacheAndaHalf »

ChpBstrd

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Right. The growth in money supply reflects the QE and government spending increases of 2020-2021. QE ended in March and government spending is falling compared to last year, as can be seen on the chart. Thus money supply growth has flattened. That is a disinflationary factor. The inflation we see today is the delayed reaction from policies enacted in 2020-2021, including a massive increase in money supply.

The idea with leveraged funds and leverage in general would be to reduce risk exposure, not add to it. Since any theory I have is either going to be dramatically right or dramatically wrong, I’m looking for ways to capture lots of upside while not wiping myself out if I’m wrong.

A small position using leveraged ETFs or long options could provide a whole portfolio’s worth of upside while only exposing a fraction of the portfolio to potential losses. Yes, this comes at a price, and so far I’ve been unwilling to pay that price. But the May CPI was strong evidence for a bearish outlook so I’m asking myself if those prices are worth it.

MustacheAndaHalf

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When you mentioned "YOLO into SQQQ ... Seriously", I wasn't sure if you meant that as a plan of action or as a rhetorical way to start the conversation.  But you don't need to help answer that - I'm curious if you have changed your mind, to what I quote below.


The idea with leveraged funds and leverage in general would be to reduce risk exposure, not add to it. Since any theory I have is either going to be dramatically right or dramatically wrong, I’m looking for ways to capture lots of upside while not wiping myself out if I’m wrong.

A small position using leveraged ETFs or long options could provide a whole portfolio’s worth of upside while only exposing a fraction of the portfolio to potential losses. Yes, this comes at a price, and so far I’ve been unwilling to pay that price. But the May CPI was strong evidence for a bearish outlook so I’m asking myself if those prices are worth it.

This aligns with my view.  If I put 1/3rd of my assets into SQQQ (-3x QQQ), I'm left with:
67% cash
-100% QQQ (1/3rd x -3x QQQ)

I would still view this as -100% QQQ, though, because that's the risk level.  In terms of expense ratios, 33.33% invested in SQQQ paying a 1% expense ratio... that translates to 0.33% of overall assets to obtain -100% QQQ exposure.  When you compare to other approaches, that's a very efficient way to get exposure.

Unfortunately when markets are volatile (like past 1.5 years), the expense ratio is far less of a problem than losing 1/4th per year to volatility.  I've flip flopped on volatility drag based on data I've seen - I have yet to apply the same analysis on the same data.  Right now I think it's good to worry about volatility drag.

An example would be QQQ -11% twice in a row, giving it a loss of -21% total (multiply, don't add: .89 x .89 = .7921).  Meanwhile SQQQ gains +33% twice in a row (1.33 x 1.33  =1.7689) and is up +77%.  While it looks like SQQQ used 3.67x leverage, what really happened was leveraged compounding.  So that's my model for LETFs (leveraged ETFs) and volatility.

vand

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In theory any interest rate below the rate of inflation is a stimulatory (why would anyone keep cash if it loses purchasing power?), so it makes perfect sense that interest rates have needed to be higher than the rate of inflation in order to tame it.

That's the theory that got a lot of portfolios demolished in 2010-2018, or at least led a lot of people to miss out on a historic and epic bull market. The FFR was below CPI for almost that entire time and yet CPI was well-behaved. On the chart, it looked like something crazy was happening that would imminently lead to inflation, but IRL there was some dis-inflationary cause out there absorbing all that QE and preventing ZIRP from pushing inflation above 2-3%.


I think a far likelier explanation is that people had just reached the point of maximum pessimism following the crushing of the GFC, couldn't handle the volatility and were scared off stocks. That's the unfortunate reality of a lot of retail investors - they buy high and sell low. 

There is a very reliable negative correlation between retail equity allocation and forward return, which shouldn't surprise anyone... this is how it has to be. When everyone is on board there are few buyers left to drive prices further, and then when everyone is on board there is always significant risk to the downside as there are more potential sellers.


The functions of capital markets is to allocate capital into the hands of those who are best able to use it - taking money from investors who piled in at the top and panic sold at the bottom is as good a way to do that as any.
« Last Edit: June 11, 2022, 03:01:43 AM by vand »

MustacheAndaHalf

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There is a very reliable negative correlation between retail equity allocation and forward return, which shouldn't surprise anyone... this is how it has to be. When everyone is on board there are few buyers left to drive prices further, and then when everyone is on board there is always significant risk to the downside as there are more potential sellers.
Retail investors hit 70% stock allocation in March 2021 according to the AAII report released April 1 2021.  Someone who sold the S&P 500 ETF ("SPY") at the closing price on that day, $395.41 has waited out of the market for 14 months, during which time the S&P 500 dropped 1.2% (to $389.80 at Friday's close).  Switching to bonds meant buying Total Bond ETF ("BND") at $82.69 at the April 1 close, and as of now BND is priced at $74.91 (w/o dividends), for a 9.4% loss offset by less than 3% of bond interest.  So far, switching to bonds trailed the market by more than 5%.

"Stock and stock fund allocations increased by 2.3 percentage points to 70.0%, marking the 10th consecutive month that equity allocations are above the historical average of 61.0%. Equity allocations were last higher in February 2018 (70.1%)."
https://www.aaii.com/latest/article/13695-march-aaii-asset-allocation-survey-37-month-high-for-equity-exposure

But I have a suggestion for the very small percent of people who buy crypto in their portfolios.  Selling GBTC on April 1 2021 would have avoided a 63% drop!  I sold my crypto in Dec 2021, and currently have some short positions in crypto stocks.

ChpBstrd

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When you mentioned "YOLO into SQQQ ... Seriously", I wasn't sure if you meant that as a plan of action or as a rhetorical way to start the conversation.  But you don't need to help answer that - I'm curious if you have changed your mind, to what I quote below.

It is a MMM person problem when allocating a fraction of one's portfolio to something is still a six figure amount. To put six, or even five, figures toward an investment as crazy as long options or leveraged funds counts as a YOLO in my book. I am talking about betting the value of my house!

The WSB people YOLO'ing their entire twenty grand net worth on Palantar call options expiring in a week probably disagree.

Of course, I wouldn't call it a YOLO if I put the same amount in VTI, so maybe I'm revealing some discomfort with short instruments. I need to watch that psychology, because big bets with low confidence equal being shaken out by short periods of losses.

Quote
Unfortunately when markets are volatile (like past 1.5 years), the expense ratio is far less of a problem than losing 1/4th per year to volatility.  I've flip flopped on volatility drag based on data I've seen - I have yet to apply the same analysis on the same data.  Right now I think it's good to worry about volatility drag.

Volatility drag is the real deal for futures-based funds. I observed this effect when I used to study the VIX-based funds UVXY/SVXY looking for arbitrage opportunities. TQQQ/SQQQ are similar in the sense that the same company runs both funds, essentially by allocating a pool of futures contracts from one ticker symbol to the other. But you'll notice there are asymmetries. For example, UVXY was up 9.15% yesterday while its short sister SVXY was only down 3.09%. A trader could have literally bought equal values of both the long and short funds and won big yesterday, as counterintuitive as that sounds!

Similarly, SQQQ gained a tenth of a percent more at close than TQQQ did. Maybe that's statistical noise, but if it was a pattern it could add up.

The search for an arbitrage opportunity, or at least an optimal strategy, involves questions like "if I want to go short, should I buy a put option on TQQQ or a call option on SQQQ?" If volatility drag affects one fund more than the other, we'd expect to see that reflected in the options market, especially for distant maturities. In general, it's thought that normal contango conditions will erode the long funds, because they are constantly trading cheaper short-duration contracts for more expensive long-duration contracts in an attempt to maintain a consistent duration as time passes. The effect is the opposite on the short funds. When backwardization occurs, the loss pattern flips. Thus a bet on a futures-based ETF is partially a bet on direction and partially a bet on whether contango or backwardization will occur. Backwardization is associated with, but not always correlated with, falling markets.

Stock index leveraged ETFs seem to have done better than the VIX products. Maybe their futures markets are more liquid.

At the moment, Nasdaq mini futures are in normal contango (further out contracts are priced higher).
https://markets.businessinsider.com/futures/nasdaq-100-futures?op=1

VIX futures are generally in contango too, but with inversions in November and December.
http://vixcentral.com/

Returning to the question of what's the better deal, a TQQQ put or a SQQQ call, we could shorthand this decision by calculating time value as a percentage of strike price minus ITM amount for the first ITM strike option. The lower percentage would be the one to buy, assuming symmetrical performance and volatility drag. Any difference might be traders' assumption about volatility drag.

One could do a similar calculation to look for arbitrage opportunities between leveraged ETF options like TQQQ and the triple the number of opposite positions on with unleveraged ETFs like QQQ. Any difference you find is likely to be the result of dividends.

MustacheAndaHalf

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When you mentioned "YOLO into SQQQ ... Seriously", I wasn't sure if you meant that as a plan of action or as a rhetorical way to start the conversation.  But you don't need to help answer that - I'm curious if you have changed your mind, to what I quote below.
It is a MMM person problem when allocating a fraction of one's portfolio to something is still a six figure amount. To put six, or even five, figures toward an investment as crazy as long options or leveraged funds counts as a YOLO in my book. I am talking about betting the value of my house!

The WSB people YOLO'ing their entire twenty grand net worth on Palantar call options expiring in a week probably disagree.

Of course, I wouldn't call it a YOLO if I put the same amount in VTI, so maybe I'm revealing some discomfort with short instruments. I need to watch that psychology, because big bets with low confidence equal being shaken out by short periods of losses.
Passive investors have more information and experience with long term returns of VTI.  So to the extent you've been a passive investor, it's rational to have more confidence the total market (VTI), which is understood better, and is widely viewed as a good long term investment.

I'm normally careful to talk only in percentages, but I have more than $9,999 in VIX calls that expire next week.  I could probably hold my own with the WSB crowd this week.


Unfortunately when markets are volatile (like past 1.5 years), the expense ratio is far less of a problem than losing 1/4th per year to volatility.  I've flip flopped on volatility drag based on data I've seen - I have yet to apply the same analysis on the same data.  Right now I think it's good to worry about volatility drag.

Volatility drag is the real deal for futures-based funds. I observed this effect when I used to study the VIX-based funds UVXY/SVXY looking for arbitrage opportunities. TQQQ/SQQQ are similar in the sense that the same company runs both funds, essentially by allocating a pool of futures contracts from one ticker symbol to the other. But you'll notice there are asymmetries. For example, UVXY was up 9.15% yesterday while its short sister SVXY was only down 3.09%. A trader could have literally bought equal values of both the long and short funds and won big yesterday, as counterintuitive as that sounds!

Similarly, SQQQ gained a tenth of a percent more at close than TQQQ did. Maybe that's statistical noise, but if it was a pattern it could add up.
...
Returning to the question of what's the better deal, a TQQQ put or a SQQQ call, we could shorthand this decision by calculating time value as a percentage of strike price minus ITM amount for the first ITM strike option. The lower percentage would be the one to buy, assuming symmetrical performance and volatility drag. Any difference might be traders' assumption about volatility drag.

One could do a similar calculation to look for arbitrage opportunities between leveraged ETF options like TQQQ and the triple the number of opposite positions on with unleveraged ETFs like QQQ. Any difference you find is likely to be the result of dividends.
This part of the conversation mostly loses me, because I haven't studied futures and commodities, where contangio is more relevent.  I guess I leave that to the market and assume it's appropriate.

I notice a lot more money in 2024 put options instead of call options.  My view isn't to play small differences in TQQQ/QQQ/SQQQ but to invest in where the market is headed over the next 12 months.  Since April I've been willing to sit out 2022 and wait for a crash.
https://finance.yahoo.com/quote/QQQ/options?p=QQQ&date=1705622400

CNN Fear & Greed index fell on Friday, and in particular "puts and call options" show "fear" right now.  Notice in the timeline view, each peak is lower than the prior one... the markets peaked in Nov 2021 in optimism/greed (so far).
https://edition.cnn.com/markets/fear-and-greed

ChpBstrd

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My first thought after reading the PPI numbers released this morning: What a disaster! +0.8% in a month.
https://www.bls.gov/news.release/pdf/ppi.pdf

CPI can't be that far behind PPI. In hindsight, PPI predicted CPI back in 2021.
https://fred.stlouisfed.org/series/PPIFID#0



Interesting things about this chart:

1) The YoY growth rate of PPI actually slowed for the 2nd month in a row. Is this minor decrease the measurable effect of a 0.75% rate hike? If that's the case, how many more rate hikes will it take?
2) There's a huge gap between the inflation producers are experiencing and the inflation consumers are experiencing. That might suggest margins are falling, or maybe imports and a strong dollar are the only things keeping CPI in check.
3)  The gap between PPI and CPI has been closing for 2 months, as CPI rises faster and PPI growth slows. Is this statistical noise, or are consumer prices catching up with past producer price increases?
4) CPI and PPI are usually tight. We are going through a period of deviation. Does that mean PPI falls or CPI rises? If there's no reason for PPI to fall, like falling fuel prices, etc., then must CPI rise to meet PPI?


ChpBstrd

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I find it really odd that markets are rallying today in response to the Fed's 0.75% rate hike, with the Nasdaq up 2.5%. That would normally seem to be really bad news for markets, and it came as a relative surprise too. 

Perhaps if markets believe the Fed will raise rates faster, that means the markets believe the overall peak of the rate hikes will be lower. The Fed's dot plot suggests they are targeting a ~3.5% rate for the end of 2022. Or maybe the markets have discounted a widely feared "too little, too late" approach by the Fed? Stocks are arguably already priced with today's rate hike in mind, it just came sooner than expected.

Maybe the real reason for the rally was that a falling PPI in May is being interpreted as signal for a falling or flat CPI in June. If the June numbers come out as CPI flat or falling, with PPI continuing to fall, then that's probably our signal for the end of this round of inflation. Recession or not, inflation would be falling from there, especially if another 0.75% hike is on the way in July. Signs of recession might be interpreted as meaning rates will never rise to 4%, because a recession could knock out inflation without the need for interest rates to continue rising. As I said earlier - bad news is good news. 

Even if we are at peak inflation (now that nobody believes it) I think we still have to worry about a housing correction. 30y loans have exceeded 6%, and that is leading to housing payments over 50% higher in most metro areas than they were back when rates were lower. Fortune offers a helpful interactive map in the second link below:
https://fortune.com/2022/06/15/mortgage-rates-spike-housing-market-real-cost-to-buy-a-home-jumps-50-percent/
https://fortune.com/2022/06/14/housing-market-correction-prices-mortgage-rates-interactive-map/
https://www.mortgagenewsdaily.com/mortgage-rates

The next unthinkable thing is that housing prices could fall. Nobody is calling for that to happen, but an uptick in unemployment due to the probably-coming recession could make it happen. Affordability is affordability. There's just not a bunch of extra money laying around any more to throw at houses, and there's no urgency to buy now that rates have doubled. The urgency of 2021 was to get a house before rates rose. Low rates ratcheted up prices, but what happens now that payments are 50% higher than mere months ago?

PDXTabs

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I find it really odd that markets are rallying today in response to the Fed's 0.75% rate hike, with the Nasdaq up 2.5%. That would normally seem to be really bad news for markets, and it came as a relative surprise too.

Markets are weird I don't think that you can read too far into one day. If this is 1980 we have a ways more to fall. But this might not be 1980.

The next unthinkable thing is that housing prices could fall. Nobody is calling for that to happen, but an uptick in unemployment due to the probably-coming recession could make it happen. Affordability is affordability. There's just not a bunch of extra money laying around any more to throw at houses, and there's no urgency to buy now that rates have doubled. The urgency of 2021 was to get a house before rates rose. Low rates ratcheted up prices, but what happens now that payments are 50% higher than mere months ago?

Yea, that could happen. What if mortgage rates double again?

EDITed to add - but maybe not in nominal terms? IDK, it is weird when there is such a lack of supply. High rates aren't going to help builders finance more of them. Also, inflation can erode real value at 9% a year now.
« Last Edit: June 15, 2022, 05:25:07 PM by PDXTabs »

clarkfan1979

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I find it really odd that markets are rallying today in response to the Fed's 0.75% rate hike, with the Nasdaq up 2.5%. That would normally seem to be really bad news for markets, and it came as a relative surprise too. 

Perhaps if markets believe the Fed will raise rates faster, that means the markets believe the overall peak of the rate hikes will be lower. The Fed's dot plot suggests they are targeting a ~3.5% rate for the end of 2022. Or maybe the markets have discounted a widely feared "too little, too late" approach by the Fed? Stocks are arguably already priced with today's rate hike in mind, it just came sooner than expected.

Maybe the real reason for the rally was that a falling PPI in May is being interpreted as signal for a falling or flat CPI in June. If the June numbers come out as CPI flat or falling, with PPI continuing to fall, then that's probably our signal for the end of this round of inflation. Recession or not, inflation would be falling from there, especially if another 0.75% hike is on the way in July. Signs of recession might be interpreted as meaning rates will never rise to 4%, because a recession could knock out inflation without the need for interest rates to continue rising. As I said earlier - bad news is good news. 

Even if we are at peak inflation (now that nobody believes it) I think we still have to worry about a housing correction. 30y loans have exceeded 6%, and that is leading to housing payments over 50% higher in most metro areas than they were back when rates were lower. Fortune offers a helpful interactive map in the second link below:
https://fortune.com/2022/06/15/mortgage-rates-spike-housing-market-real-cost-to-buy-a-home-jumps-50-percent/
https://fortune.com/2022/06/14/housing-market-correction-prices-mortgage-rates-interactive-map/
https://www.mortgagenewsdaily.com/mortgage-rates

The next unthinkable thing is that housing prices could fall. Nobody is calling for that to happen, but an uptick in unemployment due to the probably-coming recession could make it happen. Affordability is affordability. There's just not a bunch of extra money laying around any more to throw at houses, and there's no urgency to buy now that rates have doubled. The urgency of 2021 was to get a house before rates rose. Low rates ratcheted up prices, but what happens now that payments are 50% higher than mere months ago?

I wouldn't try to predict theoretical reasons for market behavior based on one day. Many random things happen within one day that could swing the market -2% or 2% that offer no explanation. It's just "Noise". This is kind of plug for Kahneman's book.

All housing markets are local. I don't really pay attention to national housing trends, just my markets. Based on my markets, there is still very low supply of houses. I do expect housing sales to slow down. However, I don't really see prices going down.

Because of the recent interest rate hike, more people are now fighting over rentals. I have a rental in Fort Myers, FL. From April 2021 to April 2022, Fort Myers, FL had the biggest rental increase in the nation (32% increase).

https://www.fox4now.com/news/local-news/lee-county/fgcu-study-fort-myers-sees-largest-rent-increase-in-the-nation-compared-to-2021


Mr. Green

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House prices are already falling in a number of smaller markets. As rates rise this trend will spread.

MustacheAndaHalf

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I heard from multiple people (including Jim Kramer) that a 0.75% rate hike would cause a market rally.  So if one person calls it noise after the fact, while another person predicted what would happen before the fact, I consider the person doing the predicting more reliable.  I do not consider Wednesday's moves noise.

Setting aside the 0.75% rate hike, the Fed's expectations took a dramatic shift Wednesday.  It wasn't just the rate hike, but how closely the Fed aligned with what the market already expects.  Given how behind the Fed has been, it's important they confirm the market expectations match their own.

For example, before the meeting markets predicted something like this:
June & July +0.75% ... Sept +0.50% ... Nov & Dec +0.25%
The Fed funds rate was in the range 0.75% to 1.00% before the meeting, so if you add everything up you get an expectation of 3.25% to 3.50% for the Fed funds rate by year end.

The Fed estimated 3.4% Fed funds by year end, falling nicely into the range the market predicted.  That also feeds the narrative that the market has predicted future rate hikes correctly, and that in turn could lead to a "soft landing".  The Fed uses harsher rate hikes up front, then eases off if conditions allow.  A "tap the breaks" approach, if you will.

If individual investors - especially passive investors - don't understand what happened in one day's market or what the Fed did, that's fine.  It's not like everyone follows the Fed closely - people are busy following the price of gas, instead.  That's actually another risk: people ask for not only a raise to catch up with past inflation, but a raise that also prices in future inflation.  If that's based on gas prices, the Fed can't do much about those, and may have to watch helplessly as inflation rises.

clarkfan1979

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I heard from multiple people (including Jim Kramer) that a 0.75% rate hike would cause a market rally.  So if one person calls it noise after the fact, while another person predicted what would happen before the fact, I consider the person doing the predicting more reliable.  I do not consider Wednesday's moves noise.

Setting aside the 0.75% rate hike, the Fed's expectations took a dramatic shift Wednesday.  It wasn't just the rate hike, but how closely the Fed aligned with what the market already expects.  Given how behind the Fed has been, it's important they confirm the market expectations match their own.

For example, before the meeting markets predicted something like this:
June & July +0.75% ... Sept +0.50% ... Nov & Dec +0.25%
The Fed funds rate was in the range 0.75% to 1.00% before the meeting, so if you add everything up you get an expectation of 3.25% to 3.50% for the Fed funds rate by year end.


The Fed estimated 3.4% Fed funds by year end, falling nicely into the range the market predicted.  That also feeds the narrative that the market has predicted future rate hikes correctly, and that in turn could lead to a "soft landing".  The Fed uses harsher rate hikes up front, then eases off if conditions allow.  A "tap the breaks" approach, if you will.

If individual investors - especially passive investors - don't understand what happened in one day's market or what the Fed did, that's fine.  It's not like everyone follows the Fed closely - people are busy following the price of gas, instead.  That's actually another risk: people ask for not only a raise to catch up with past inflation, but a raise that also prices in future inflation.  If that's based on gas prices, the Fed can't do much about those, and may have to watch helplessly as inflation rises.

When I add up these numbers, I get 2.25% to 2.5%, not 3.25% to 3.5%. What did I miss?

Are you saying June (+.75%), July (+.75%), September (+.50%), November (+.25%) and December (+.25%)?
« Last Edit: June 16, 2022, 10:53:02 AM by clarkfan1979 »

MustacheAndaHalf

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I heard from multiple people (including Jim Kramer) that a 0.75% rate hike would cause a market rally.  So if one person calls it noise after the fact, while another person predicted what would happen before the fact, I consider the person doing the predicting more reliable.  I do not consider Wednesday's moves noise.

Setting aside the 0.75% rate hike, the Fed's expectations took a dramatic shift Wednesday.  It wasn't just the rate hike, but how closely the Fed aligned with what the market already expects.  Given how behind the Fed has been, it's important they confirm the market expectations match their own.

For example, before the meeting markets predicted something like this:
June & July +0.75% ... Sept +0.50% ... Nov & Dec +0.25%
The Fed funds rate was in the range 0.75% to 1.00% before the meeting, so if you add everything up you get an expectation of 3.25% to 3.50% for the Fed funds rate by year end.


The Fed estimated 3.4% Fed funds by year end, falling nicely into the range the market predicted.  That also feeds the narrative that the market has predicted future rate hikes correctly, and that in turn could lead to a "soft landing".  The Fed uses harsher rate hikes up front, then eases off if conditions allow.  A "tap the breaks" approach, if you will.

If individual investors - especially passive investors - don't understand what happened in one day's market or what the Fed did, that's fine.  It's not like everyone follows the Fed closely - people are busy following the price of gas, instead.  That's actually another risk: people ask for not only a raise to catch up with past inflation, but a raise that also prices in future inflation.  If that's based on gas prices, the Fed can't do much about those, and may have to watch helplessly as inflation rises.

When I add up these numbers, I get 2.25% to 2.5%, not 3.25% to 3.5%. What did I miss?

Are you saying June (+.75%), July (+.75%), September (+.50%), November (+.25%) and December (+.25%)?
I probably should have put this line first:
"The Fed funds rate was in the range 0.75% to 1.00% before the meeting"


Rates started this year at 0.00% to 0.25%, and then moved up +0.25% in March, and another +0.50% in May.  So before this week, Fed funds rate was already 0.75%.

The Fed raised rates 0.75% yesterday, bringing the lower bound to 1.50%

So maybe July +0.75% brings Fed funds 2.25%
then slower in September at +0.50% leaving Fed funds 2.75%
and very likely a slow November before elections +0.25% giving 3.00%
finally, the December +0.25% rate hike bringing the end result to 3.25%

(That was the lower bound, add 0.25% for the upper bound: 3.25% to 3.50%)

ChpBstrd

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Quote
Traders of so-called fixings, or derivatives-like instruments related to Treasury inflation-protected securities, expect four straight months of annual headline consumer-price index readings at roughly 9% or higher from June through September.

Quote
The outlook for a roughly 9% September CPI rate has been in place since May’s CPI report was released last Friday, one trader said.

Quote
As of Thursday, data compiled by Bloomberg indicated that fixings traders expect the annual headline CPI rate to come in at 8.97% and 8.95%, respectively, for June and July — up from May’s 8.6% level. From there, year-over-year CPI is expected to hit 9.15% in August and 9.08% in September before gradually falling off to 4.7% in May of next year.

Quote
“Monetary policy certainly acts with a lag and the market is saying monetary policy is not going to ease the oil shortage in the next two months, and it’s not going to help food prices or get wheat out of Ukraine in the next few months,” McReynolds said via phone on Thursday. “For the next few months, the fixings market realizes that the main sticking points of inflation are something raising rates are not really going to take care of.”

https://www.marketwatch.com/story/u-s-inflation-expected-to-keep-running-hot-traders-see-4-straight-months-of-roughly-9-or-higher-cpi-readings-11655399963?mod=home-page

I'll file this under rumors because I cannot directly access the "fixings" market or monitor when this information changes. These derivative trades are almost certainly one side of long-inflation + short-inflation hedged positions. Also, this is probably a tiny market comprised of traders who... are concerned about inflation, and their projection seems to be at odds with the 5 year inflation expectations in the much more liquid TIPS/treasuries spread. Still, this is a valuable model based on a real market with money at stake rather than an armchair forecast or government report.

If things turn out as the "fixings" traders expect, we're looking at 0.75% or larger hikes from every 2022 Fed meeting at the least, and stocks/bonds continuing to plummet. I entered a large bear put spread on TLT yesterday, which I plan to close before the next CPI announcement. The more I think about the falling PPI trend, high inventories, recession expectations, and demand destruction, the more I think going to neutral before each CPI announcement is the way to avoid being caught wrong-footed this summer. If a "bottom" typically comes 6 months before a recession, and the recession is likely to demolish inflation, then it's a matter of calling the recession. Right now, expectations are for the recession to hit in mid-2023 but we have yet to have a meaningful 2/10 yield curve inversion and the NFCI is still in a slow climb that most resembles 1977.

https://home.treasury.gov/resource-center/data-chart-center/interest-rates/TextView?type=daily_treasury_yield_curve&field_tdr_date_value_month=202206
https://fred.stlouisfed.org/series/NFCI

EscapeVelocity2020

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Expectation is for another 75 bp hike from the Fed July 27th - https://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html

We're in for some crazy volatility!  Still think we have more pain to work though - either inflation will stay too hot, or the economy will cool off and earnings will fall...  But if the pain gets bad enough, the Fed could cave to instant gratification, slowing hikes but letting inflation run higher than the 2% target.  Any way you look at it, risk is very high until inflation really starts to cool off.  As far as I can tell, consumers aren't showing signs of slowing down.

MustacheAndaHalf

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Expectation is for another 75 bp hike from the Fed July 27th - https://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html

We're in for some crazy volatility!  Still think we have more pain to work though - either inflation will stay too hot, or the economy will cool off and earnings will fall... 
I might misunderstand, but I assume "crazy volatility" refers to the 0.75% Fed funds rate hike expected on July 27th.  I disagree, as I think volatility will be lower when the Fed is delivering what the market expects.

Based on prior FOMC meetings, I believe minutes of last week's meeting will be released on July 6 2022.  The Fed often gives guidance, which I expect will match the market expectation of 0.75% rate hike at the late July meeting.  When the market has near certainty of an event, volatility is lower.

The market and Fed were surprised by the June 10 inflation data, which showed "peak inflation" might be wrong, and that inflation might not fall quickly.  The volatility from last week was driven by that uncertainty over what inflation meant and how the Fed would react to it.  The Fed meeting within a week of surprise inflation data is key context.

Also worth noting I put my money where my mouth is on that volatility.  The "volatility index" or ^VIX is derived from S&P 500 options prices (a month out, I think).  I bought leveraged call options when the ^VIX was near $25, and cashed out when it was $32 to $33 (on Monday, June 13).

ChpBstrd

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Expectation is for another 75 bp hike from the Fed July 27th - https://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html

We're in for some crazy volatility!  Still think we have more pain to work though - either inflation will stay too hot, or the economy will cool off and earnings will fall...  But if the pain gets bad enough, the Fed could cave to instant gratification, slowing hikes but letting inflation run higher than the 2% target.  Any way you look at it, risk is very high until inflation really starts to cool off.  As far as I can tell, consumers aren't showing signs of slowing down.

It's also possible that most traders have an idea in their head that they're going to buy stocks amid aggressive rate hikes, and then enjoy future returns like anyone who bought stocks amid the early 80's recessions. I personally think any such trader would be jumping the shark by many months and many percent, but what matters is what they think. They sold in Jan-June and are now sitting in cash waiting for a signal that things are getting better.

That sounds like a losing game to me. Why not just wait for valuations and yields to come down to levels that will support a 4-5% WR retirement, such as PE's in the mid-teens and 10y treasury yields around 5-6%? And if that never happens, what are the odds that the cost of missing out on a fast rising market fails to compensate me for the risk I avoided when I sat on the sidelines during a massive rate hiking campaign? Why throw a Hail Mary now of all times?

Additionally, the 1970s and 1980s inflation spikes featured false dawns followed by a return of inflation. There's a lot of whipsaw possibility there for the traders.

EscapeVelocity2020

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The volatility will come from oversold/ short selling bets and limit orders being filled.  A small increase will result in sharp upward pressure, for at least a day or two.

We are in the inscrutable time again when bad economic news might be perceived as good - economy is weakening on its own allowing the Fed to relax.  Long term market returns are dominated by the Fed ever since QE and ZIRP took over the market.  Heaven forbid we actually have to depend on companies producing innovative products and high quality earnings...

This is why I'm not a trader, I just want to hold on to my FI long term.  This was my last big trade, from the 'Top is In' thread -
Made it to 4500, sold everything… Top has finally arrived.  Congrats to all the diamond hands that made it…

ChpBstrd

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The CRB commodity index and S&P GSCI commodity index have taken a plunge since the hot CPI reading was released in early June. Crude oil fell from over $120/barrel to near $110.

https://tradingeconomics.com/commodity/crb
https://tradingeconomics.com/commodity/gsci
https://tradingeconomics.com/commodity/crude-oil

Traders are perhaps upping their estimates for demand destruction and their estimated odds of recession. The irony is that their actions in dialing back commodities bets could lower prices, forestall demand destruction, and make a recession less likely. These thoughts may be why stocks have rallied that last two days. But the commodities traders and the stock traders are clearly envisioning different outcomes, aren't they?

I don't want to dismiss these movements as mere noise, though. If commodities are flat or falling through June, then perhaps the June CPI number released in early July could be a pleasant surprise. A pleasant surprise CPI number would NOT be a pleasant surprise for my time decay bets on volatile short instruments! So I'll be watching commodities closely for clues about whether now is the time to take profits.

One of my favorite bloggers, EarlyRetirementNow.com wrote up a list of his favorite recession indicators. They include the yield curve, weekly unemployment claims, and the purchasing managers index. The PMI seems too noisy and after-the-fact to be useful IMO, and I already follow the yield curve, but ERN has a point about weekly unemployment claims. These data often provide a heads-up months or even a full year before a recession. Given that low unemployment is essentially the bull case right now, it's worth watching.




BicycleB

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Here is a new source, proposing a new model and critiquing the assumptions of standard models:

https://mattstoller.substack.com/p/on-inflation-its-the-monopoly-profits

Stoller writes on the topic of monopoly / oligopoly, asserting that the US economy and people would benefit from stronger and properly implemented regulation in this area. He seems to have served as a staffer in the US Senate Budget Committee but I don't find evidence that he's an economist. If I understand him, Stoller asserts that:

1. A significant portion of the inflation surge (perhaps 60%??) is due to monopolistic pricing power within particular industries, not just macroeconomic factors
2. The supply chain effect on inflation includes key examples where inflation is large because of industry concentration, would be not as large otherwise
3. US has already passed law and begun regulation to reduce this in the shipping industry but wider efforts are needed both from an inflation viewpoint and an economic efficiency standpoint

I assume that one consequence of his theory is that conventional approaches toward inflation will fail to some extent because they don't address one of inflation's major causes. Perhaps there are investment opportunities in recognizing when the Fed will fail and to what extent?

Stoller says he himself wrote an early article on the proposed link between oligopoly and inflation but also links to several later articles by professional economists studying and he says confirming aspects of the proposed model.

PS. Please don't assume that my attempt to summarize is that great, it's just one reader's attempt. There's a lot in there. I will welcome corrections, clarifications, and the pointing out of more important aspects than I expressed.
« Last Edit: June 22, 2022, 05:30:30 PM by BicycleB »

AnnS

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I wouldn't be able to tell if there's anything you missed but thank you for the brevity and clarity of your explanations. Your post was one of the most enlightening piece of economic nerdism that I've read.

ChpBstrd

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The next CPI release is July 13. It may be two weeks premature but I'll go ahead and throw out a prediction: June CPI will be slightly lower than May CPI. I predict the CPI's index value will be 293.5, a YoY increase of 8.3%. Not only did CPI experience an upward blip in Jun 2021 that makes for a harder comparison than we had in May, but also...

Commodities have been falling since the first week in June:
https://tradingeconomics.com/commodity/gsci

...including the all-critical crude oil price, which is now "down" to late-May levels:
https://tradingeconomics.com/commodity/crude-oil

Initial jobless claims are trending up very slightly, suggesting that the economy is starting to slow and wage pressure may be declining:
https://fred.stlouisfed.org/series/ICSA

It's not 100% clear what the market reaction would be if my prediction came true. The S&P500 is up about 6.5% since mid-June, and it seems this is related to optimism that May was the peak of this year's inflationary episode. Speculative money is moving out of commodities, as these bets will not do well in a coming recession or amid higher interest rates. This new narrative about commodities could create a self-reinforcing cycle as evidence accrues for a slowing economy and a Fed set to raise rates as quickly as possible, causing people to flee commodities, and causing inflation to go down.

Still, investors are aware that stocks hit their bottom amid recessions, so everyone wants to buy at the turning point of maximum pessimism - the point at which we realize we're in a recession. The rapid turn in commodities prices, rock-bottom producer and consumer sentiment, a rapidly-tightening NFCI, and a negative Q1 GDP growth number suggest the recession could come sooner than expected - particularly when comparing growth metrics to the juiced-up go-go year of 2021. We may be due for the next big bear rally.



Viking Thor

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I won't even venture a guess about the next inflation report but I found this article with some data points interesting. I am not knowledgeable enough to know how significant things like the price of copper are in the inflation big picture as leading indicators.

https://www.cnn.com/2022/06/26/business/recession-signs-roundup/index.html

ChpBstrd

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Recession has become the mainstream expectation. From a (paywalled) WSJ article:

Quote
S&P Global’s measure of activity in the eurozone’s manufacturing sector, known as the purchasing managers index or PMI, indicated that factory output fell in June and was at its weakest level since August 2020.

Factories indicated that sharper falls are likely to come, with new orders falling at the fastest pace since May 2020. As a result of blockages in global supply chains and staff shortages, many factories had been unable to keep up with demand during the rapid bounceback from the initial hit to demand caused by the onset of the pandemic. Now the eurozone survey shows that backlogs of work fell for the first time in almost two years.

Quote
In another sign of weakening demand, the cost of shipping a 40 foot container from China to the U.S. West Coast was down 15% week over week June 29, according to the Freightos Baltic Index, and was 14% lower than a year earlier.
Source: https://www.wsj.com/articles/cooling-demand-for-goods-threatens-to-turn-pandemic-boom-into-bust-11656674342

This combined with the recent commodities correction (CRB index down 12%, oil down 10.1% from early June peaks) suggest traders expect a recession is
]=43on the way. Energy and financial stocks could have a lot further to fall if that's the case, due to declining commodity prices and increasing bad loans / bond and mortgage write-downs. However regional retail banks like RF and SFNC are trading at single-digit PE ratios, just like mega-banks C, MS, and GS. Meanwhile the energy sector's trailing PE ratio is only 12.3 (https://csimarket.com/Industry/industry_valuation_ttm.php?pe&s=600).

Is there a case to be made that at these valuations a recession is already priced in? That financials and energy are safe bets and that there's only upside if a recession doesn't happen? What if the commodities indexes, Baltic Dry Index, slumping manufacturing demand, pitiful consumer confidence, etc. all reflect a transition from a stimulus-fueled economy back to a normal economy? Isn't this exactly what we'd expect to see in that scenario too?

I'm not convinced, but I'm also reducing my short exposure because it's no longer obvious that things are overpriced when we have a recession on the way. Recession is the consensus view, and stocks could actually rise from here, through the recession and all, if the recession is shallow. If the commodities markets collapse and inflation starts falling rapidly, there could be a monster rally and recalculation of how high rates will go.

EscapeVelocity2020

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Since this thread was about inflation and interest rates, I didn't think recession was relevant, but the latest prediction of GDP growth has turned negative recently - https://www.atlantafed.org/cqer/research/gdpnow
Quote
The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the second quarter of 2022 is -2.1 percent on July 1, down from -1.0 percent on June 30. After this morning's Manufacturing ISM Report On Business from the Institute for Supply Management and the construction report from the US Census Bureau, the nowcasts of second-quarter real personal consumption expenditures growth and real gross private domestic investment growth decreased from 1.7 percent and -13.2 percent, respectively, to 0.8 percent and -15.2 percent, respectively.

The next GDPNow update is Thursday, July 7.
« Last Edit: July 01, 2022, 01:41:12 PM by EscapeVelocity2020 »

clarkfan1979

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Recession has become the mainstream expectation. From a (paywalled) WSJ article:

Quote
S&P Global’s measure of activity in the eurozone’s manufacturing sector, known as the purchasing managers index or PMI, indicated that factory output fell in June and was at its weakest level since August 2020.

Factories indicated that sharper falls are likely to come, with new orders falling at the fastest pace since May 2020. As a result of blockages in global supply chains and staff shortages, many factories had been unable to keep up with demand during the rapid bounceback from the initial hit to demand caused by the onset of the pandemic. Now the eurozone survey shows that backlogs of work fell for the first time in almost two years.

Quote
In another sign of weakening demand, the cost of shipping a 40 foot container from China to the U.S. West Coast was down 15% week over week June 29, according to the Freightos Baltic Index, and was 14% lower than a year earlier.
Source: https://www.wsj.com/articles/cooling-demand-for-goods-threatens-to-turn-pandemic-boom-into-bust-11656674342

This combined with the recent commodities correction (CRB index down 12%, oil down 10.1% from early June peaks) suggest traders expect a recession is
]=43on the way. Energy and financial stocks could have a lot further to fall if that's the case, due to declining commodity prices and increasing bad loans / bond and mortgage write-downs. However regional retail banks like RF and SFNC are trading at single-digit PE ratios, just like mega-banks C, MS, and GS. Meanwhile the energy sector's trailing PE ratio is only 12.3 (https://csimarket.com/Industry/industry_valuation_ttm.php?pe&s=600).

Is there a case to be made that at these valuations a recession is already priced in? That financials and energy are safe bets and that there's only upside if a recession doesn't happen? What if the commodities indexes, Baltic Dry Index, slumping manufacturing demand, pitiful consumer confidence, etc. all reflect a transition from a stimulus-fueled economy back to a normal economy? Isn't this exactly what we'd expect to see in that scenario too?

I'm not convinced, but I'm also reducing my short exposure because it's no longer obvious that things are overpriced when we have a recession on the way. Recession is the consensus view, and stocks could actually rise from here, through the recession and all, if the recession is shallow. If the commodities markets collapse and inflation starts falling rapidly, there could be a monster rally and recalculation of how high rates will go.

@ChpBstrd

Would you be willing to share the trades you made?

I would be interested to know the ideas that were successes and the other ideas that were failures. 

ChpBstrd

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Since this thread was about inflation and interest rates, I didn't think recession was relevant, but the latest prediction of GDP growth has turned negative recently - https://www.atlantafed.org/cqer/research/gdpnow
Quote
The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the second quarter of 2022 is -2.1 percent on July 1, down from -1.0 percent on June 30. After this morning's Manufacturing ISM Report On Business from the Institute for Supply Management and the construction report from the US Census Bureau, the nowcasts of second-quarter real personal consumption expenditures growth and real gross private domestic investment growth decreased from 1.7 percent and -13.2 percent, respectively, to 0.8 percent and -15.2 percent, respectively.

The next GDPNow update is Thursday, July 7.

Awesome find @EscapeVelocity2020 ! Recession is a direct factor to the interest rate and inflation rate, so it's very relevant. I'm glad you found this before I spent too much time guessing GDP! This looks much worse than I was thinking.

Today's ISM survey was deeply negative, causing investors to accelerate their estimated timeframe for recession. If the rapid swing in GDPNow is any indicator, we may be in for a "full-employment recession" like I alluded to earlier. There is such an excess of job openings to job seekers, that millions of jobs could vaporize and there'd still be plenty of work available for almost everyone, while unemployment stays below 5% or 6%.

Particularly, if the recession is occurring now and those millions of jobs will disappear in the 2nd half of 2022, then it's likely that inflation is about to plummet, and the Fed will be able to stop the rate hikes in early 2023 rather than late 2023 or early 2024, ending somewhere in the 3-4% range. That's why stocks rallied today after the ISM survey was released. Bad news is good news if it means inflation is heading down and the prospect of a 5-8% federal funds rate is off the table.

I'm very tempted to switch my stance from bearish to hedged-bullish. Yes, there are a lot of scary headlines ahead about unemployment, contagion from cryptocurrency meltdowns and sovereign debt issues, energy prices, war, corporate bond defaults, rising foreclosures, plummeting earnings, and whatever economic crisis comes out of nowhere in response to rapidly changing conditions. But, barring a major financial crisis, the stock market loves to climb exactly that wall of worry. The number of things to be worried about has historically been correlated with long-term returns.

@ChpBstrd

Would you be willing to share the trades you made?

I would be interested to know the ideas that were successes and the other ideas that were failures. 

I've been sitting mostly in cash since early March, with limited forays into different directions. My timing WRT bear rallies has been horrendous! In hindsight, even when I got the long-term market direction right, my returns have been haphazard and subject to chance and timing. If one is convinced the market is moving in a particular direction, they should make long-duration bets. I lacked conviction, so I made shorter-term bets whose outcome is more determined by market noise than correct premises.

What worked:
     Deep-ITM covered calls on SQQQ (still holding)
     Buying a put on TQQQ
     A large one-week bear put spread on TLT at 115.5/116.5 earned me $5k against $45k at risk, but I barely won the wager!
     Bear put spreads on BBBY and CHWY
     Holding IAU for a bit
     A series of covered calls on OHI at the 30 and 33 strikes

What didn't work:
     OTM covered calls on SQQQ
     A bear put spread on GME
     Low-PE small and mid-cap ETFs like VB, VBR, and VO on the assumption low-valuation = low risk
     A covered call on SARK (still holding)
     Holding small-cap LYSDY on the expectation that inflation would boost the stock (still holding a few hundred shares, long-term)

When I go long again, history says the way to do that is with growth stocks. I like Microsoft, Salesforce, Chewy, Apple, Roblox, and Australian rare-earths refiner Lynas. I would also take a good look at the iShares convertible bond ETF (ICVT). Given the evidence of demand destruction, I would consider buying long-duration puts or bear spreads on USO, because oil almost always plummets in recessions. Finally, I have my eye on several investment-grade bonds yielding in the 6%-7% range, such as a 2093 maturity by BBB+ rated Disney that yield 7% and some BBB tobacco bonds that might do well in a more conservative political environment. Those bonds look a lot like instant retirement compared to the market's inflation breakeven rates!

clarkfan1979

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Since this thread was about inflation and interest rates, I didn't think recession was relevant, but the latest prediction of GDP growth has turned negative recently - https://www.atlantafed.org/cqer/research/gdpnow
Quote
The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the second quarter of 2022 is -2.1 percent on July 1, down from -1.0 percent on June 30. After this morning's Manufacturing ISM Report On Business from the Institute for Supply Management and the construction report from the US Census Bureau, the nowcasts of second-quarter real personal consumption expenditures growth and real gross private domestic investment growth decreased from 1.7 percent and -13.2 percent, respectively, to 0.8 percent and -15.2 percent, respectively.

The next GDPNow update is Thursday, July 7.

Awesome find @EscapeVelocity2020 ! Recession is a direct factor to the interest rate and inflation rate, so it's very relevant. I'm glad you found this before I spent too much time guessing GDP! This looks much worse than I was thinking.

Today's ISM survey was deeply negative, causing investors to accelerate their estimated timeframe for recession. If the rapid swing in GDPNow is any indicator, we may be in for a "full-employment recession" like I alluded to earlier. There is such an excess of job openings to job seekers, that millions of jobs could vaporize and there'd still be plenty of work available for almost everyone, while unemployment stays below 5% or 6%.

Particularly, if the recession is occurring now and those millions of jobs will disappear in the 2nd half of 2022, then it's likely that inflation is about to plummet, and the Fed will be able to stop the rate hikes in early 2023 rather than late 2023 or early 2024, ending somewhere in the 3-4% range. That's why stocks rallied today after the ISM survey was released. Bad news is good news if it means inflation is heading down and the prospect of a 5-8% federal funds rate is off the table.

I'm very tempted to switch my stance from bearish to hedged-bullish. Yes, there are a lot of scary headlines ahead about unemployment, contagion from cryptocurrency meltdowns and sovereign debt issues, energy prices, war, corporate bond defaults, rising foreclosures, plummeting earnings, and whatever economic crisis comes out of nowhere in response to rapidly changing conditions. But, barring a major financial crisis, the stock market loves to climb exactly that wall of worry. The number of things to be worried about has historically been correlated with long-term returns.

This is my general attitude as well.

@ChpBstrd

Would you be willing to share the trades you made?

I would be interested to know the ideas that were successes and the other ideas that were failures. 

I've been sitting mostly in cash since early March, with limited forays into different directions. My timing WRT bear rallies has been horrendous! In hindsight, even when I got the long-term market direction right, my returns have been haphazard and subject to chance and timing. If one is convinced the market is moving in a particular direction, they should make long-duration bets. I lacked conviction, so I made shorter-term bets whose outcome is more determined by market noise than correct premises.

100% agree. I think longer bets are going to have less error variance (noise) and be more likely to be correct.

What worked:
     Deep-ITM covered calls on SQQQ (still holding)
     Buying a put on TQQQ
     A large one-week bear put spread on TLT at 115.5/116.5 earned me $5k against $45k at risk, but I barely won the wager!
     Bear put spreads on BBBY and CHWY
     Holding IAU for a bit
     A series of covered calls on OHI at the 30 and 33 strikes

What didn't work:
     OTM covered calls on SQQQ
     A bear put spread on GME
     Low-PE small and mid-cap ETFs like VB, VBR, and VO on the assumption low-valuation = low risk
     A covered call on SARK (still holding)
     Holding small-cap LYSDY on the expectation that inflation would boost the stock (still holding a few hundred shares, long-term)

When I go long again, history says the way to do that is with growth stocks. I like Microsoft, Salesforce, Chewy, Apple, Roblox, and Australian rare-earths refiner Lynas. I would also take a good look at the iShares convertible bond ETF (ICVT). Given the evidence of demand destruction, I would consider buying long-duration puts or bear spreads on USO, because oil almost always plummets in recessions. Finally, I have my eye on several investment-grade bonds yielding in the 6%-7% range, such as a 2093 maturity by BBB+ rated Disney that yield 7% and some BBB tobacco bonds that might do well in a more conservative political environment. Those bonds look a lot like instant retirement compared to the market's inflation breakeven rates!

I am not really big on picking individual stocks, but during the 2012 stock market recovery, I decided to pick one stock for fun. Microsoft slid from $32 in early 2012 to $27 in late 2012. Around the same time Apple stock went up from $15 to $20 and seemed to be dominating the headlines in tech. As a result, my long-term play was 100 shares of Microsoft at $27. However, I was in the process of rehabbing a house and the repairs ended up being higher than expected, so I didn't buy any Microsoft shares. Even though Microsoft is now at $260, I actually still made more money with the house because the real estate money was leveraged. I put 5% down on a 95K house that is now worth 375K. It now rents for $2150/month and market rent is $2450/month. I gave a discount to the current tenants for being good tenants.

Based on your wins and losses, could you provide your "theory" for the bet? You have too many listed to do this for all of them. Could you pick your favorite win and favorite loss and describe the thought process? Please describe what were you expecting to happen and what actually happened. I think it would be really interesting to read. 

PDXTabs

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This recession is going to be weird. Car sale are projected to fall to 2012 levels, but not because people don't want to buy cars. They just can't seem to make enough to fill demand. Jalopnik: Car Sales to Go Down 17 Percent Despite Strong Demand: Report

ChpBstrd

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Based on your wins and losses, could you provide your "theory" for the bet? You have too many listed to do this for all of them. Could you pick your favorite win and favorite loss and describe the thought process? Please describe what were you expecting to happen and what actually happened. I think it would be really interesting to read.

Long Calls or Puts: Risk a relatively small amount of money to bet against stocks or hedge. Theory: I think the market is going down but I'm a chicken so I want a firm floor on my potential losses. I want limited losses and leveraged upside. The downside is that options are expensive when volatility is high, as it is now. Against my better judgment I paid the excess time premium and it usually didn't work out.

Covered Calls: Volatility through the roof and VIX>30 means you are being paid a lot more than usual for selling a call option. When paired with an already volatile short ETF like SQQQ, you are making a bet that will make money unless the market has a huge rally. Harvesting the time decay of those calls can be quite lucrative for something as volatile as SQQQ - like ~5% of the price of the underlying per week for a call at-the-money.

OTM Covered Calls on Triple Inverse ETFs: If we get a little bit less greedy and more risk averse, we can still play this game by selling calls at a price far below the strike price. We capture less time decay this way, but we have a covered call where the underlying asset has to lose a significant amount of value before the position even starts to lose value. E.g. if SQQQ is $55, I might sell a call at $50. At the end of the week, I will have to sell the asset for which I paid $55 for $50, but I will also get to keep the, let's say, $6.50 I was paid for the call. When I bought the stock for $55 and sold the call for $6.50, my net debit was $48.50. If I have to sell at $50, I just made $1.50 profit. I only lose if SQQQ goes below $48.50. That could happen in the event of a sudden bear market rally, which is why I'm easing out of these plays.

SARK: ARKK includes a lot of companies with negative earnings and speculative outlooks. Not the kind of things people will gravitate toward as economic anxieties increase and interest rates rise. SARK is a fund set up to be the inverse of ARKK, and it has an options market too. This is a good alternative to SQQQ for those with extreme bearish views. Again, SARK is what you'd invest in if you were convinced the market was going down. I'm not as convinced any more.

LYSDY: I have like $2500 tied up in this little microcap for entertainment. They are unique in the fact that they have some of the only ex-China rare earth metals refining capability and technology and they don't pay a dividend to muck up my taxes. This is a hedge against increased US-China tensions and also a very-long-run lotto ticket. The US government just gave them a $100M contract to set up a refinery in TX because they're the only non-Chinese firm with the proven expertise.

Each and every one of these strategies won or lost due to the timing of bear market rallies and dips. The lesson is to take a longer view rather than trying to harvest short-term cash profits. That's another case for going long now, rather than waiting for even worse news than what we've seen.

clarkfan1979

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Based on your wins and losses, could you provide your "theory" for the bet? You have too many listed to do this for all of them. Could you pick your favorite win and favorite loss and describe the thought process? Please describe what were you expecting to happen and what actually happened. I think it would be really interesting to read.

Long Calls or Puts: Risk a relatively small amount of money to bet against stocks or hedge. Theory: I think the market is going down but I'm a chicken so I want a firm floor on my potential losses. I want limited losses and leveraged upside. The downside is that options are expensive when volatility is high, as it is now. Against my better judgment I paid the excess time premium and it usually didn't work out.

Covered Calls: Volatility through the roof and VIX>30 means you are being paid a lot more than usual for selling a call option. When paired with an already volatile short ETF like SQQQ, you are making a bet that will make money unless the market has a huge rally. Harvesting the time decay of those calls can be quite lucrative for something as volatile as SQQQ - like ~5% of the price of the underlying per week for a call at-the-money.

OTM Covered Calls on Triple Inverse ETFs: If we get a little bit less greedy and more risk averse, we can still play this game by selling calls at a price far below the strike price. We capture less time decay this way, but we have a covered call where the underlying asset has to lose a significant amount of value before the position even starts to lose value. E.g. if SQQQ is $55, I might sell a call at $50. At the end of the week, I will have to sell the asset for which I paid $55 for $50, but I will also get to keep the, let's say, $6.50 I was paid for the call. When I bought the stock for $55 and sold the call for $6.50, my net debit was $48.50. If I have to sell at $50, I just made $1.50 profit. I only lose if SQQQ goes below $48.50. That could happen in the event of a sudden bear market rally, which is why I'm easing out of these plays.

SARK: ARKK includes a lot of companies with negative earnings and speculative outlooks. Not the kind of things people will gravitate toward as economic anxieties increase and interest rates rise. SARK is a fund set up to be the inverse of ARKK, and it has an options market too. This is a good alternative to SQQQ for those with extreme bearish views. Again, SARK is what you'd invest in if you were convinced the market was going down. I'm not as convinced any more.

LYSDY: I have like $2500 tied up in this little microcap for entertainment. They are unique in the fact that they have some of the only ex-China rare earth metals refining capability and technology and they don't pay a dividend to muck up my taxes. This is a hedge against increased US-China tensions and also a very-long-run lotto ticket. The US government just gave them a $100M contract to set up a refinery in TX because they're the only non-Chinese firm with the proven expertise.

Each and every one of these strategies won or lost due to the timing of bear market rallies and dips. The lesson is to take a longer view rather than trying to harvest short-term cash profits. That's another case for going long now, rather than waiting for even worse news than what we've seen.

Thanks for sharing. It was a great read.

EscapeVelocity2020

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Great thread, really enjoying the conversations.  @clarkfan1979 - I believe that picking individual stocks might be the only way to really make money in the coming years.  So many people invest in the indices and only pay attention to them that they will likely think markets are flat for a long time while certain stocks are outperforming.  For people that don't have the time or inclination to follow stocks, this will be a tough market to make money.  Index investors had it good for the last decade or so, now landlords get the good life.

@ChpBstrd It's hard to formulate any good opinion on where stocks in general are headed this year.  On one hand, the Fed being less aggressive and bond yields falling help stocks, but recessions generally hurt company earnings, especially since so much US economy is leveraged on services and advertising (megacap tech stocks, for instance).  I love hearing people's theories about where the market is headed, so many 'investors' just parrot 'buy the dip' and then complain why we aren't back at new highs yet. 

MustacheAndaHalf

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My prior experience was that call options on QQQ and SQQQ are the same - probably driven by every SQQQ options seller knowing it's relationship to QQQ.  I thought I'd revisit that given the mention of "long calls on triple inverse ETFs".

QQQ at $282.13 using calls expiring 2023-Jan-20
https://finance.yahoo.com/quote/QQQ/options?date=1674172800&p=QQQ
ATM $280 strike $28.12/sh (9.2% time/sh)
6x $250 strike $47.36/sh (5.4% time/sh)
2x $140 strike $142.90/sh (0.3% time/sh)

SQQQ at $57.62 using calls expiring 2023-Jan-20
https://finance.yahoo.com/quote/SQQQ/options?date=1674172800&p=SQQQ
ATM $57 strike $17.14 (28.7% time/sh)
2x $28 strike half bid-ask spread $31.20/sh (1.8% time/sh)

TQQQ at $24.39 using calls exporing 2023-Jan-20
https://finance.yahoo.com/quote/TQQQ/options?p=TQQQ&date=1674172800
ATM $23.75 strike $6.65 (25.3% time value)
1.77x $13.75 strike $12.55 (7.8% time value)

What I see are 3x funds charging 3x time value for ATM calls.  So I would modify the speculation on long calls in 3x inverse ETFs: avoid buying ATM calls.

A more complex comparison is 6x QQQ compared to 2x TQQQ (2x calls on 3x QQQ = also 6x).  Two points favor QQQ here: (1) TQQQ doesn't offer 2x calls, so there's less choice  (2) time values for available calls suggest they are fairly close (5.4% vs 7.8%), and all else being equal it's better to trade on the market with more activity: QQQ.

For a specific level of leverage, I would avoid "long calls on ... 3x ETFs", and instead focus on the same leverage using the underlying ETF (like QQQ).

less4success

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I believe that picking individual stocks might be the only way to really make money in the coming years.  So many people invest in the indices and only pay attention to them that they will likely think markets are flat for a long time while certain stocks are outperforming.  For people that don't have the time or inclination to follow stocks, this will be a tough market to make money.  Index investors had it good for the last decade or so, now landlords get the good life.

It's fairly common for index gains to be driven by a (relatively) small subset of exceptional companies, so I'm planning to continue indexing as normal:

https://archive.ph/boeEP

wageslave23

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I believe that picking individual stocks might be the only way to really make money in the coming years.  So many people invest in the indices and only pay attention to them that they will likely think markets are flat for a long time while certain stocks are outperforming.  For people that don't have the time or inclination to follow stocks, this will be a tough market to make money.  Index investors had it good for the last decade or so, now landlords get the good life.

It's fairly common for index gains to be driven by a (relatively) small subset of exceptional companies, so I'm planning to continue indexing as normal:

https://archive.ph/boeEP

I agree. Plus I don't think that I am more intelligent or more knowledgeable than the majority of fund managers.  In theory I don't see how I could identify an underpriced stock that the world's best asset managers have not already identified and bid up to it's fair price. If say stock x is priced at $40 and it really should be $50 based on its fundamentals and future earnings, then why hasn't Buffett and all the other fund managers with billions of dollars and infinitely more resources and insider knowledge already identified the under valuation and bid it up to $50?

EscapeVelocity2020

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    • EscapeVelocity2020
I believe that picking individual stocks might be the only way to really make money in the coming years.  So many people invest in the indices and only pay attention to them that they will likely think markets are flat for a long time while certain stocks are outperforming.  For people that don't have the time or inclination to follow stocks, this will be a tough market to make money.  Index investors had it good for the last decade or so, now landlords get the good life.

It's fairly common for index gains to be driven by a (relatively) small subset of exceptional companies, so I'm planning to continue indexing as normal:

https://archive.ph/boeEP

I agree. Plus I don't think that I am more intelligent or more knowledgeable than the majority of fund managers.  In theory I don't see how I could identify an underpriced stock that the world's best asset managers have not already identified and bid up to it's fair price. If say stock x is priced at $40 and it really should be $50 based on its fundamentals and future earnings, then why hasn't Buffett and all the other fund managers with billions of dollars and infinitely more resources and insider knowledge already identified the under valuation and bid it up to $50?

I'm not giving advice for anybody, just my personal opinion.  I understand how the S&P500 index funds work.  For instance, I was worried when TSLA got added at such a high valuation, but realized it was still a tiny fraction of the total return, even if it ended up losing significant value.

https://www.researchaffiliates.com/publications/articles/832-revisiting-teslas-addition-to-the-sp500
Quote
We have observed that additions and deletions to the S&P 500 Index follow a dependable pattern: additions underperform and deletions overperform over the subsequent 12-month period. The December 2020 rebalance out of AIV and into TSLA lived up to this pattern rather spectacularly—at the six-month mark, AIV has a relative return advantage over TSLA of 78%!
« Last Edit: July 02, 2022, 04:39:37 PM by EscapeVelocity2020 »