Tag Archives: Investing

Hold To Maturity – A Fuzzy Framework for Fixed Income Investing

Reading Time: 3 minutes

I have been seeing quite a few articles about the decline in bond prices and the bond bear market.

These are excellent headlines, but appear to be fighting the last battle.

Many investors appear to be evaluating fixed income investments without considering hold to maturity.  Isn’t hold to maturity the primary way you should be evaluating fixed income?  

You lend money to the borrower for a fixed amount of time, the borrower is contractually obligated to pay you a coupon, and at maturity give you your principal back.  That is why they call it fixed income. The returns are not ambiguous.  As a fixed income investor you care about yield, duration, and credit quality (i.e., getting your principal back).

Decades of declining interest rates appear to have made that framework fuzzy.  With fixed income, declining yields lead to price increases.  A long period of declining rates appear to have lulled fixed income investors to sleep a bit.  Or distracted fixed income investors from the fundamentals.

However, if investors are focusing on the short-term price movements of fixed income investments, then they are trading, not investing.  Price increases have historically not been what fixed income investors should be counting on.  Again, fixed income investors should be focusing on yield, duration, and getting their principal back at the end of all that. 

Expecting price increases in fixed income implies expecting lower rates in the future.  Another dimension that investors need to realize is that the Fed does not control longer rates.  The Fed sets short term rates. Longer rates are determined by many things including supply and demand and the inflation outlook.  So the Fed could lower short rates, but that’s no guarantee that long rates follow suit.  The yield curve is still inverted mind you.  

This topic also ties into Howard Marks’ latest article where a main point was – if an investor could achieve their target returns with fixed income, why would they consider investing in equities.  Marks is using the traditional framework for fixed income – hold to maturity.  Short term price movements are not something to focus on.

ETFs could also be causing some issues here.  ETFs tend to hold many issues, even if they are the same type, and therefore do not have a clear maturity date.  For example, the iShares 7 – 10 Year Treasury Bond ETF (symbol: IEF) holds 13 issues with a 2.93% current yield, 4.69% 30 day SEC Yield, and weighted average duration of 8.37 years.  So ETFs hold multiple issues, which are changing as the fund sells issues and purchases new ones.  And, the yield is not fixed as is the case with a single issue.  So, bond ETFs are sort of a composite issue, but not really, which also makes hold to maturity a bit fuzzy.

What is also interesting here is the difference between the current yield (last dividend annualized) and the 30 Day SEC yield, 2.93% and 4.69% in the case of IEF, respectively.  The current yield is nowhere close to the yield on new 10 year treasuries, but this would be expected since older issues are yielding much lower rates.  The fund cannot payout income it is not receiving.  

The older issues would also have a current market price well below par.  Those issues should theoretically increase in price as they get closer to maturity.  Recall, bond investors will get their principal back at maturity unless the borrower defaults.

It is not entirely clear to me  why the current yield and 30 day SEC yield differ so much, but presumably reflects the fact that some of the issues the fund holds are below par and would be expected to increase in price as they get closer to maturity.   I am also unclear how price increases would eventually make their way into investors’ hands, since iit does not appear to be happening through the current dividend.  It seems possible the funds are reflecting that “accrued interest” in the 30 day SEC yield.

All of that makes ETF bond funds a bit confusing and not exactly like an individual bond.

© 2023 Something For The Effort LLC  – All Rights Reserved

This commentary on this website reflects personal opinions, viewpoints, and analyses and is not financial or investment advice.

The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data, or any recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.

Surging Bond Yields with Downtown Josh Brown

Reading Time: 2 minutes

This was so good on so many levels.

Catch me on Scott Galloway’s show

Long End of the Curve + Velocity:

28:11

An absolutely great dissertation on the yield curve, impact of rates, and flow through into the economy so far.  So many good points here, you just need to listen to the whole conversation.

Keep in mind, velocity matters a lot. Long rates matter way more than short rates.  There may be lags and some structural weirdness, but I am in this camp.

Catalyst:

44:07

“You need the shock.  What is the exogenous shock that is going to happen that is all of a sudden make the recession real.?”

Spenders gonna spend.  This has been my thesis for a while.  The American consumer is not going to stop spending until they are literally stopped from spending.  American consumers will spend until they run out of money or, more likely, cannot get credit any longer.

Rates are impacting this already.

Hold To Maturity:

50:52

I disagree with this somewhat.  Not his attractiveness of the starting yield discussion; I agree with that point. 

However, if I buy a 30 Year Treasury Bond with a 5% yield, and hold it for 30 years, then my (nominal) return is literally going to be 5% every year.  How would it not be, assuming the U.S. government doesn’t default (I felt I had to add this caveat, unfortunately)?  Only if I look at price on a short term basis and mark-to-market or sell the bond prior to its maturity will my return vary.  This is like the whole point of a bond.  It is why they call it fixed income.

In my opinion, too many fixed income investors are focusing on price movements (i.e., trading) and not focusing on yield and duration.  The fact that yields have come down for 20 years, has probably caused too many fixed income investors to focus on price movements.  ETFs also distort this a bit for a couple of reasons.  More on this later.

Credit Spreads:

53:37

“Spreads have not blown out…and until they do stop saying recession.”

Yes, totally, spot on.  Watch credit…especially consumer credit.  See above.

© 2023 Something For The Effort LLC  

Bears Watching: Cash & Real Estate

Reading Time: < 1 minute

I love this chart produced by Capital Spectator on a monthly basis:

Two things I find interesting:

  1. Cash is still the best performing asset through the one year mark.  Actually, cash is the only positive performing asset (in nominal terms).
  2. And the poor performance of Foreign Real Estate over five years. Foreign real estate is the worst performing asset, at least in U.S. dollar terms.

Influential Reads – March 2023

Reading Time: 3 minutes

Influential Reads – March 2023

“If you’re going to panic, panic first.” – Old adage

Well, March was exciting.  Inflation and bank failures…a recipe for…the stock market to crush it?

In my first full month of semi (?) retirement, we had a bunch of house guests and made a short trek up to Ketchum, Idaho for some skiing at Sun Valley and skating at Galena Lodge .  

Here are my most influential reads for the month – in no particular order:

  1. Satyajit Das: SVB Collapse and Bank Turmoil – Latest Chapter in the Unwinding – “The assumption that raising rates and withdrawing monetary stimulus would result in a painless adjustment back to a new normal was naïve in the extreme.”  SMS here: It’s not just the change in magnitude, it’s the velocity.
  2. Dissecting Goldman’s gory $2.25bn SVB equity issue – “Second, the stock offering has to be underwritten. Hard-underwritten. Or already subscribed-for. Investors must assess the equity offering on the basis of a repaired balance sheet. They must know you don’t actually need them.”
  3. The Powell of Positive Thinking – “He clearly signaled (again) that once Fed overnight policy rates reach a peak, they would not be declining for a while. “
  4. Risk Capital and Markets: A Temporary Retreat or Long Term Pull Back? – “It behooves both investors and traders to therefore track movements in risk capital, since it is will determine when long term bets on value will pay off for the former, and the timing of entry into and exit from markets for the latter.”
  5. Highlights from Charlie Munger’s Conversation with Todd Combs (2022 Singleton Prize for CEO Excellence) – “It’s the nature of things that a bunch of democratically-elected politicians will eventually print too much money.”
  6. Free Money Turned Brains to Mush, Now Some Banks Fail – “And when I say “free money” with regards to banks, I mean it literally.  Since 2008, banks have been borrowing from depositors at 0% interest or near 0% interest. Even today, even as some banks are trying to attract more deposits by offering higher interest rates, even today when the Fed’s short-term rates are near 5%, the average interest rate on savings accounts is still only 0.4%. Even today, 0.4%.” SMS: This is nuts.
  7. Venture Catastrophists – “There are no libertarians in foxholes.”
  8. Is Inflation Mean-Reverting? – “What that means – and it is super important – is that inflation has momentum. Keep in mind that during most of the period shown here, the Federal Reserve was actively trying to make inflation mean-revert. And they didn’t succeed, at least on a one-year basis.”
  9. Banking Woes Hark Back to the S&L Crisis of the 1980s – “Former Fed Reserve Chairman Paul Volcker used high rates to squeeze inflation out of the economy four decades ago, and the savings & loan industry was among the unintended victims. “
  10. The easiest way to spot a market bubble – “New Metrics get invented while timeless investing principles become a thing of the past.”  See Cash EBITDA. SMS: During the sale of my business last year, the investment bankers wanted me to use “Cash EBITDA”, but they could not even provide a definition.

Note: This is based on when I read the article, not necessarily when it was first published.  Unfortunately, my backlog of things I would like to read always seems to dwarf the amount of time I can devote to reading.

Top clicks across the site last month:

  1. Financial Model vs. Operating Model
  2. Bears Watching: Short Yields & Fed Funds Rate
  3. Excel Tips: Football Field Chart
  4. Operating Model Tips
  5. Email: Don’t Fire & Forget

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Bears Watching: Short Yields & Fed Funds Rate

Reading Time: < 1 minute

Wow. Stunning collapse in short duration yields.

Source: Marketwatch.com

Over 100 bps on the two year.

And what is even more interesting to me is the gap between the current Fed Funds target rate and these rates:

Source: Bloomberg.com

Seems like that is going to need to resolve itself somehow, at some point.

Are Credit Conditions Tightening Again?

Reading Time: 2 minutes

Despite the Fed raising interest rates, credit conditions were actually relaxing on some levels in the back half of 2022.

“Financial conditions have loosened significantly in recent months and, by some measures, are around levels that prevailed last March when the Fed initiated this hiking cycle.” – Why the Federal Reserve Should Raise Rates by Half a Percent

Equities were rallying through this period, unsurprisingly.  So, were digital bit apes and other assorted things.

However, there appears to be evidence that credit conditions are now heading the other way:

  1. “The Federal Reserve has reduced its balance sheet by $626 billion since the peak in April 2022, with total assets now down to $8.34 trillion, the lowest since August 2021, according to the weekly balance sheet released today. Compared to a month ago, total assets dropped by $94 billion.” “Over the past four weeks, the Fed has shed $61.2 billion in Treasury securities, exceeding by a smidgen the monthly cap of $60 billion.” – Fed’s Balance Sheet Drops by $626 Billion from Peak
  2. “The only time conditions have tightened this much has been in advance of or during the last 4 recessions since 1990.” – Credit conditions in Q4 were recessionary
  3. “As it stands, the average lender is now back up into the low 7’s for a well-qualified 30yr fixed scenario. These aren’t the highest levels we’ve seen during this cycle, but they are the highest in more than 4 months (and not too far away from the long-term highs just under 7.4%).” – Calculated Risk: “Mortgage Rates Now Back Above 7%”

We have had a 15 year bull market with low interest rates and lots of liquidity.  In other words, “Disneyland.”

My sense is most market participants are going to be slow to change how they learned to behave during the bull market cycle, until they are forced to do so.  

Influential Reads – February 2023

Reading Time: 3 minutes

Influential Reads – February 2023

“Standards apply not just to the quality of work you produce but the opportunities you work on. If you accept substandard work from yourself, you’ll only get average work from others. If you say yes to average projects, you’ll have no time for exceptional ones.” – Brain Food, Farnam Street

Big news in my world: I resigned my CFO role at a private equity backed software maker after selling the business to a new private equity group.  I will be taking some time off to “to evaluate, to collect, to dream, to wonder and to wander.”

Reading and writing more is definitely a goal.

Here are my most influential reads for the month – in no particular order:

  1. Jim Chanos: The Golden Age of Fraud in Finance – ” One of the things that is as old as financial markets is that we don’t see oversight or new laws and regulations until after people lose money.”
  2. “Disinflation” Hoopla Sunk by Spiking Prices – “Not only did all the relevant measures get a lot worse in January, but the prior three months, October through December, were revised higher – much like the CPI inflation readings a couple of weeks ago – showing substantially greater inflation momentum at the end of the year than originally shown.”
  3. The Wisdom of Non-Effort – “Non-effort is letting yourself take a walk and notice what comes up for you as something to write about, and trusting that”
  4. Just Twenty-Five Pages a Day – “The solution I devised for myself is a simple one: 25 pages a day. That’s it. Just commit to that, and then do it.”
  5. Buffett Profile from 1979: “The investor’s investor” – “The essence of Warren Buffett’s thinking is that the business world is divided into a tiny number of wonderful businesses well worth investing in at a price and a huge number of bad or mediocre businesses that are not attractive as long-term investments.”
  6. When TIPS Outperform and How I Invest in Them – “TIPS outperform regular Treasuries when the market underestimates future inflation.”
  7. We Are All Bond Traders Now – “What this means is that if interest rates are low, you care a great deal about the interest rate. Any change to your numerator is easily wiped out by a small change in the interest rate you are discounting at.”
  8. The Forgotten Lessons of 2008: Seth Klarman – “You must buy on the way down. There is far more volume on the way down than on the way back up, and far less competition among buyers. It is almost always better to be too early than too late, but you must be prepared for price markdowns on what you buy.”
  9. Enough Part 2 – A Framework – Calibrating Capital – “Too many of us run too hard for too long, reaching a point of exhaustion (or worse) when we could have taken a breather (or several of them) long ago.”
  10. Microsoft and the Metaverse – “I suspect that this is the path that virtual reality will take. Like PCs, the first major use case will be knowledge workers using devices bought for them by their employer, eager to increase collaboration in a remote work world, and as quality increases, offer a superior working environment.”

Note: This is based on when I read the article, not necessarily when it was first published.  Unfortunately, my backlog of things I would like to read always seems to dwarf the amount of time I can devote to reading.

Top clicks across the site last month:

  1. Sign of the Times: New Homes For Rent
  2. Financial Model vs. Operating Model
  3. Excel Tips: Football Field Chart
  4. Operating Model Tips
  5. Influential Reads – January 2023

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Influential Reads – November 2022

Reading Time: 2 minutes

“Nothing gets people to look the other way like easy money.” – Does Not Compute, Collaborative Fund

I am very tired of seeing articles about FTX and SBF.

Here are my most influential reads for the month – in no particular order:

  1. Getting Wealthy vs. Staying Wealthy – “But there’s only one way to stay wealthy: some combination of frugality and paranoia.”
  2. That Sound You Hear Is the Fed Breaking Something – “As I have stated before, the Fed will keep hiking until something breaks, and clearly the cracks are forming.”
  3. Borrowing Surge Makes Quick End to Rate Hikes Unlikely – “Even as money growth is stalling, Joseph Carson, former chief economist at AllianceBernstein, points out that bank credit growth is booming. “
  4. The Munger Operating System: A Life That Works – “You want to deliver to the world what you would buy if you were on the other end.”
  5. Inflation Tends to Linger. Could It Last a Decade This Time? – “Given that U.S. inflation has run above 6% for the past year and over 8% for the seven months through September (before dipping to 7.8% in October), history indicates that the median time it will take before inflation eases below 3% is 10 years. “
  6. Here’s How Quitting Can be Your Competitive Advantage – “Imagine it’s a year from now and you stayed in your current position. What are the chances that you’re happy?”
  7. Papa Doble. Hemingway Revisited. – “The toolbox for achieving great financial outcomes has changed quickly, as have the accompanying implications of these higher, risk-free, short-term rates.”
  8. The Pandemic Housing Bubble is bursting—U.S. home prices falling 15% looks ‘conservative’ – “That Pandemic Housing Boom coincided with a staggering 42% jump in U.S. home prices between March 2020 and June 2022. At least 60% of that appreciation, researchers at the Federal Reserve Bank of San Francisco estimate, can be attributed to the elevated demand for “space” that occurred during the pandemic.”
  9. Committed & Unattached: A Powerful Way to Work – “But while you’re committed to making it happen, you are unattached to the outcome.”
  10. Higher Interest Rates Alone Won’t Fix the Inflation Problem – “The problem is that the longer the Fed’s balance sheet stays elevated, the more likely it is that QE becomes irreversible.”

Note: This is based on when I read the article, not necessarily when it was first published.  Unfortunately, my backlog of things I would like to read always seems to dwarf the amount of time I can devote to reading.

Top clicks across the site last month:

  1. Financial Model vs. Operating Model
  2. Excel Tips: Football Field Chart
  3. EBITDA Is Not A Good Proxy For Cash Flow
  4. Influential Reads – October
  5. Operating Model Tips

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Influential Reads – October 2022

Reading Time: 3 minutes

“If you stick to a path that is no longer worth pursuing, whether it’s a relationship that isn’t going well, or a stock that you’re invested in that’s losing money, or an employee that you’ve hired who isn’t performing, that is when you lose ground.” – Brain Food, Farnam Street

I have some thoughts here, but have not had the time to put them into writing.  So I am not sure if they are good thoughts or not.  

I continue to feel the risks here are massive and still mostly hidden, and there is a good chance of getting squished.  Which I would prefer not to have happen.  Squishing mechanisms include but are not limited to U.S. treasury market illiquidity, imbalances created by the currency market / massive USD strength, and real estate market trend changes.

Midterm elections will be interesting.  But I cannot watch.  There seems to be a faction of people that are “bat shit” crazy.  And there is not a rational middle ground between “bat shit” crazy and not “bat shit crazy”.  So, we should just stop trying.  But tolerating “bat shit” crazy is not a good option.

And, I think you have witnessed peak Zuckerberg and Musk, but for slightly different reasons.  Do you want to be bold and call peak Private Equity while we are at it?

Continuing to notch some “easy” reads:

And that got me to my objective:

Here are my most influential reads for the month – in no particular order:

  1. Rare Skills – “People don’t like leaving opportunities on the table, and it’s counterintuitive to realize that you’ll likely end up with more than those whose appetite for more is insatiable.”
  2. Brief amicus curiae of The Onion filed – “Rising from its humble beginnings as a print newspaper in 1756, The Onion now enjoys a daily readership of 4.3 trillion and has grown into the single most powerful and influential organization in human history.” SMS: Not a follower of the Onion, but this is some inspirational writing.
  3. August JOLTS report: the game of reverse musical chairs in the jobs market is ending – “This is simply more confirmation that consumption leads employment, and we should expect monthly jobs numbers to decelerate further, and go to virtually zero m/m by early next year.”
  4. Harvard predicts looming markdowns to private assets – ” Private funds, however, have not been adjusted to reflect new market conditions, and many have gained in value through to the end of mid-year — a disconnect Harvard predicts will hit portfolios later.”
  5. What to Buy? Bonds. When? Now. – “Looking at the latter half of the 1970s, however, rates increased from 5% to 10%, yet bonds kept making money.”
  6. Summary of My Post-CPI Tweets – “It’s a mistake, the same one people are making in rents & home prices. Rates of change could mean-revert. Prices will not. Prices are permanently higher, b/c the amount of money in the system is permanently higher. This chart shows the price level. Not going back to the old days.”
  7. E-Bikes Need Their Own Classification System on Public Land – “Rapidly increasing E-mountain bike (eMTB) use on non-motorized trails is increasing these conflicts and impacts.”  SMS: Explain to me how a eMTB is not a motorized vehicle?  Is a Tesla not motorized?
  8. You weren’t supposed to see that – “In total, the Federal government created $4.3 trillion in direct economic stimulus of which $3.95 trillion was dropped onto the economy, as if by helicopter, in a period of under 18 months.”
  9. 3 Reasons International Investing Hasn’t Paid Off – “…the U.S. dollar has recently enjoyed its strongest run in 20 years.”
  10. The bond market massacre of September 2022 – “The fear is that as central banks end the long period in which they systematically supported bond markets, deep cracks will be exposed. “

Note: This is based on when I read the article, not necessarily when it was first published.  Unfortunately, my backlog of things I would like to read always seems to dwarf the amount of time I can devote to reading.

Top clicks across the site last month:

  1. Financial Model vs. Operating Model
  2. That’s a bunch of…
  3. Influential Reads – September
  4. EBITDA Is Not A Good Proxy For Cash Flow
  5. Excel Tips: Football Field Chart

Updated stats:

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January891
February1100
March1023
April1032
May1343
June740
July822
August1127
September724
October614
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Total93926