I hope this note finds you + family doing well. Happy Halloween.
Yesterday the U.S. Federal Reserve cut interest rates with the stock market at an all-time high, relatively solid economic fundamentals, and President who is comfortable explicitly bullying (the Fed.) and pumping the stock market.
Hallucinated green light
And I slammed on the gas
My performance ain't perfect
But it's loud and it's fast
The financial markets have effectively been broken. The real rate of interest on savings is now negative. Interest Rates - Inflation = Real rate. 1.5%-1.9%= (0.40%).
At present, on a real return basis (after inflation), over $37 Trillion of global bonds have negative yields - and $9T in the U.S.
Even element 79-Au has a positive Real yield in this environment. 79-Au is Gold.
As mentioned, the collective and consensual hallucination of lower and lower rates is a lift to asset prices. Rates down = asset prices up (but forever?).
Once upon a time the economic cycle, earnings, and fundamentals mattered. We are in a new world.
Additionally, the fear of missing out can be overwhelming. Managing ones behavior is always the hard part.
Negative savings rates "encourage" money to flow into higher yielding and riskier securities, not exactly where a retiree, pension fund, insurance co. et al. wants to find itself.
As rates trend lower we find that risk aversion is discouraged and the miracle of compound interest begins to work in reverse. In order to fund any future liability, savers/pensions/401k etc. must reach further out on the risk curve and increase the amount in savings.
All financial institutions are dependent on "float" - think Warren Buffett/Berkshire insurance. Berkshire, all banks, all insurance cos. are forced to amend their investment strategy - fundamentally altering their underlying risk profile. The distortion of asset prices has a ways to go.
I will save the notes on negative interest rates until later. That one really takes some time to fully understand.
I have no confidence in my understanding of future, we must wake up and play what is before us.
However, Forest Capital is built around risk adjusted returns, and our ethos demands that safety of principal is paramount.
Risk averse securities have had tremendous returns in 2019 and we are grateful.
In recent weeks, we have accelerated purchases of higher yielding positions with solid underlying credit quality and will cling to these yields as long as they exists.
Net, net, we want to own durable and dependable cash flows.
Thank you for allowing us to work for you.