Investing

How to (Almost) Double Your Investing Returns 2. Buy Deep in the Money Calls

Scott Buchanan6 Comments

Last week we described a simple way to achieve roughly double investing returns on some asset class like an S&P 500 stock basket, or a narrow class of stocks such as semiconductors, or on some commodity like gold or oil. That way is to buy one of the many exchange-traded funds (ETFs) which use sophisticated derivatives to achieve a 2X or even 3X daily movement in their share prices, relative to the underlying asset. For instance, if the S&P 500 stocks move up by 2% on a given day, the SSO ETF will rise by 4%.

Of course, these leveraged funds will also go down two or three times as much. They also have a more subtle disadvantage, which is that when the markets go up and down a lot, they tend to lose value due to their daily reset mechanism.

In this post we describe a different way to achieve roughly double returns, which does not suffer from this volatility drag issue. This way is to buy long-dated deep in-the-money call options on a stock or a fund.

Say what? We have described how stock options work here and here. The reader who is unfamiliar with options should consult those prior articles.

A stock option is a contract to buy (if it is a call option) or to sell (if it is a put option) a given stock at some particular price (“strike price”), by some particular expiration date. Investors generally buy calls when they believe that the price of some stock or fund will go up.  For a call option with a strike price far below the current market price of a stock, the market price of the option will move up and down essentially 1:1 with the market price of the stock.

For instance, as I write this the market price of Apple is about $230. Suppose I think Apple is going to go up by say $40 in the next six months. One way for me to capture this gain is to invest $230 in buying Apple stock. The alternative propose here is to instead of buying the stock itself, buy, say, a call option with a strike price of $115 and an expiration date of January 17, 2025. The current market price of this option is about $119.

Other things being equal, we expect that the market value of this call option will go up by $40 if Apple itself goes up by $40. But we have invested only $119, rather than $230, so our return on our investment is roughly double with the option than by buying the stock itself.

There is a subtle cost to this approach. At a stock price of $230 and a strike price of $115, the intrinsic value of this call option is $115. But we pay an extra $3 of extrinsic value when we buy the option for $118. This extrinsic value will gradually decay to zero over the next six months.

Thus, if Apple went up by $40 within the next month or so, we could turn around and sell this call option for nearly $40 more than our purchase price. But if we wait for six months before selling it, we would only net $37 (i.e., $40 minus $3). This is still fine, but it illustrates that there is a steady cost of holding such options. This annualized cost is about equal to or slightly higher than the prevailing short term interest rate (5% /year). This option pricing makes sense, since an alternative way to control this many shares would be to borrow money at current interest rates (5%) and use those borrowed funds to buy Apple shares. Options and futures pricing is generally rational, to make things like this equivalent, or else there would be easy arbitrage profits available.

As a side comment, the reason I am focusing on deep in the money calls here is that the extrinsic premium you pay in buying the call gets lower the further away the strike price is (i.e. deeper in the money) from the current stock price. A deeper in the money call does cost you more up front, but net net its dollar movements up and down more closely track (1:1) the movements of the underlying stock. So, if I am not trying to guess right on any market timing, but simply want to get the equivalent of holding the underlying stock but tying up less money to do so, I find buying a call that is about 50% in the money generally works well.

How I Use Deep in the Money Call Options

I consider the technology-oriented stock fund QQQ to be a core holding in my portfolio, so I would like to stay exposed to its movements. But I might as well do this on a 2X basis, to make better use of my funds. I do hold some of the 2X ETF QLD. But if we experience a lot of market volatility, the price of QLD will suffer, as explained in our previous post.

As a more conservative approach here, I recently bought a deep in the money call on the QQQ ETF. As usual, I went for a call option with a strike price roughly half of the market price, with an expiration date 6-12 months away. When this gets close to expiration (May-June next year), I will “roll” it forward, by selling my existing call option, and buying a new one dated yet another 6-12 months further out. This takes little work and little decision making. I will pay the equivalent of about 5% annualized cost on the decay of the extrinsic option premium, but I come ahead as long as QQQ goes up more than 5% per year.

This is a little more work than just holding the 2X QLD ETF, but it gives me a bit more peace of mind, knowing I have done what I can to smooth out some of the risk there. Of course, if QQQ plunges along with the markets in general, I will be looking at double the losses. For that reason, I am taking some of the money I am saving by using these leveraged approaches, and stashing it in safe money market funds. In theory that should give me “dry powder” for buying more stocks after they drop. In practice, I may be too frozen with fear to make such clever purchases. But at any rate, I should not be appreciably worse off for having used these leveraged investments (2X funds or deep in the money calls).

Disclaimer: As usual, nothing here should be considered advice to buy or sell any investment.

From Cubicles to Code – Evolving Investment Priorities from 1990 to 2022

Zachary BartschLeave a comment

I’ve written before about how we can afford about 50% more consumption now that we could in 1990. But it’s not all bread and circuses. We can also afford more capital. In fact, adding to our capital stock helps us produce the abundant consumption that we enjoy today. In order to explore this idea I’m using the BEA Saving and Investment accounts. The population data is from FRED.

The tricky thing about investment spending is that we need to differentiate between gross investment and net investment. Gross investment includes spending on the maintenance of current capital. Net investment is the change in the capital stock after depreciation – it’s investment in additional capital not just new capital.  Below are two pie charts that illustrate how the composition of our *gross investment* spending has changed over the past 30 years. Residential investment costs us about the same proportion of our investment budget as it did historically. A smaller proportion of our investment budget is going toward commercial structures and equipment (I’ve omitted the change in inventories). The big mover is the proportion of our investment that goes toward intellectual property, which has almost doubled.

It’s easiest for us to think about the quantities of investment that we can afford in 2022 as a proportion of 1990. Below are the inflation-adjusted quantities of investment per capita. On a per-person basis, we invest more in all capital types in 2022 than we did in 1990. Intellectual property investment has risen more than 600% over the past 30 years. The investment that produces the most value has moved toward digital products, including software. We also invest 250% more in equipment per person than we did in 1990. The average worker has far more productive tools at their disposal – both physical and digital. Overall real private investment is 3.5 times higher than it was 30 years ago.

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How to Roughly Double Your Investing Returns 1. 2X (or 3X) Leveraged Funds

Scott Buchanan7 Comments

Most years, stocks go up, by something like 9%. Wouldn’t it be nice to invest in a fund that went up double those amounts? Such funds exist. They use futures or other derivatives to move up (or down!) by double, or even triple, the percentage that the underlying stock or index moves, on a daily basis.

For instance, a common unleveraged fund (ETF) is SPY that roughly tracks the S&P 500 index of large U.S. stocks is SPY. SSO is a 2X fund, which gives double the returns of SPY, on a daily basis. UPRO is a 3X fund, giving triple the returns. 2X funds exist for many different asset classes, including semiconductor stocks, treasury bill, and crude oil – see here. And similarly for 3X funds.

Since all the action in stocks these days seems to be in large tech companies, I will focus on the NASDAQ 100 index universe. The leading unleveraged fund there is QQQ. The 2X version is QLD, and the 3X is TQQQ. Let’s look at how these three funds performed over the past twelve months:

QQQ is up a respectable 36%, but QLD is up by 70%, and TQQQ by a mouth-watering 106%. You could have doubled your money in the past twelve months simply by investing in a 3X fund instead of holding boring 1X QQQ. 

These leveraged funds can be utilized in more than one way. One approach is to just put the monies you have allocated for stocks into such funds, and hope for higher returns. Another approach is to put, say half of your speculative funds into a 2X fund (to get roughly the same stock exposure as putting all of it into a 1X fund), and then use the remaining half to put into other investments, or to keep as dry powder to give you the option to buy more equities if the market crashes.

What’s not to like about these funds? It turns out that a year of daily doubling of returns does not necessarily add up to doubling of yearly returns. There is “volatility drag” associated with all the exaggerated moves up and down. As an illustration of how this works, suppose you held a stock that went down by 50% one day, say from a price of $100 to $50. The next day, it went back up by 50%. But this would only get you back to $75, not $100.

It turns out that with these leveraged funds, as long as stocks are generally going up, the yearly returns can match or even exceed the 2X or 3X targets. But in a period with a lot of volatility, the yearly returns can fall far short. And in a down year, the combination of the leverage and the volatility drag lead to truly horrific losses. For instance, here is what 2022 looked like for these funds:

QQQ was down by 31%, which is bad enough. But imagine your $10,000 in TQQQ melting down to $3,300 that year.

And here is the chart from January 2022 to the present:

QQQ is up 27% in the past 2.5 years, 2X QLD is up only 16%, while 3X TQQQ is actually down by 6%, as it could not recovery from 2022.

This was a kind of a worst-case scenario, since 2022 was an exceptionally bad year for QQQ, coming off a fabulous 2021. A chart of the past five years, which includes the 2020 Covid crash and recovery, and the 2022 crash and subsequent recovery still shows the leveraged funds coming out ahead over the long term:

The net returns on QLD (321%) were about double QQQ (158%), while the more volatile TQQQ return (386%) was plenty high, but fell well short of three times QQQ.

In my personal investing, I hold some QLD as a means to free up funds for other investments I like. But if I smell major market trouble coming, I plan to swap back into plain QQQ until the storm clouds pass.

There are some other ways to get roughly double returns, which suffer less from volatility drag than these 2X funds. I will address those in subsequent posts.

Disclaimer: As usual, nothing here should be considered advice to buy or sell any investment.

Coming In to Land

James Bailey3 Comments

And I twisted it wrong just to make it right
Had to leave myself behind
And I’ve been flying high all night
So come pick me up, I’ve landed

-Fed Chair Ben Folds on the Covid inflation

The Fed has now almost landed the plane, bringing us down from 9% inflation during the Covid era to something approaching their 2% target today. But it is not yet clear how hard the landing will be. Back in March I thought recurrent inflation was still the big risk; now I see the risk of inflation and recession as balanced. This is because inflation risks are slightly down, while recession risk is up.

Inflation remains somewhat above target: over the last year it was 3.3% using CPI, 2.7% by PCE, and 2.8% by core PCE. It is predicted to stay slightly above target: Kalshi estimates CPI will finish the year up 2.9%; the TIPS spread implies 2.2% average inflation over the next 5 years; the Fed’s own projections say that PCE will finish the year up 2.6%, not falling to 2.0% until 2026. The labels on Kalshi imply that markets are starting to think the Fed’s real target isn’t 2.0%, but instead 2.0-2.9%:

The Fed’s own projections suggest this to be the somewhat the case- they plan to start cutting over a year before they expect inflation to hit 2.0%, though they still expect a long run rate of 2.0%. In short, I think there is a strong “risk” that inflation stays a bit elevated the next year or two, but the risk that it goes back over 4% is low and falling. M2 is basically flat over the last year, though still above the pre-Covid trend. PPI is also flat. The further we get from the big price hikes of ’21-’22 with no more signs of acceleration, the better.

But I would no longer say the labor market is “quite tight”. Payrolls remain strong but unemployment is up to 4.0%. This is still low in absolute terms, but it’s the highest since January 2022, and the increase is close to triggering the Sahm rule (which would predict a recession). Prime-age EPOP remains strong though. The yield curve remains inverted, which is supposed to predict recessions, but it has been inverted for so long now without one that the rule may no longer hold.

Looking through this data I think the Fed is close to on target, though if I had to pick I’d say the bigger risk is still that things are too hot/inflationary given the state of fiscal policy. But things are getting close enough to balanced that it will be easy for anyone to find data to argue for the side that they prefer based on their temperament or politics.

To me the big wild card is the stock market. The S&P500 is up 25% over the past year, driven by the AI boom, and to some extent it pulls the economy along with it. The Conference Board’s leading economic indicators are negative but improving overall this year; recently their financial indicators are flat while non-financial indicators are worsening.

Overall things remind me a lot of the late ’90s: the real economy running a bit hot with inflation around 3% and unemployment around 4%; the Fed Funds rate around 5%; and a booming stock market driven by new computing technologies. Naturally I wonder if things will end the same way: irrational exuberance in the stock market giving way to a tech-driven stock market crash, which in turn pushes the real economy into a mild recession.

Of course there is no reason this AI boom has to end the same way as the late-90’s internet boom/bubble. There are certainly differences: the Federal government is running a big deficit instead of a surplus; there are barely a tenth as many companies doing IPOs; many unprofitable tech stocks already got shaken out in 2022, while the big AI stocks are soaring on real profits today, not just expectations. Still, to the extent that there are any rules in predicting stock crashes, the signs are worrying. Today’s Shiller CAPE is below only the internet and Covid meme-stock bubble peaks:

Again, this doesn’t mean that stocks have to crash, or especially that they have to do it soon; the CAPE reached current levels in early 1998, but then stocks kept booming for almost two years. I’m not short the market. But the macro risk it poses is real.

Boardroom Backstabbing: The Rise of “Lender-on-Lender Violence”

Scott BuchananLeave a comment

When I first started reading of “Lender-on-Lender Violence” this year, images of bankers in three-piece suits brawling in the streets of Lower Manhattan came to mind. It turns out that this is a staid legal term for a practice which has been around for some time, but is becoming more common and consequential.

Consider a case where say three lenders (e.g. banks or more likely venture capital funds) have lent money to some startup or struggling company XYZ. Let’s call these lenders A, B, and C. Now XYZ needs even more funding, perhaps because they need to build another factory, or perhaps because things are not working out as they hoped and they cannot pay off the original loans and still stay in business.

Now Lenders A and B get together and cook up a scheme. They will lend some more money to company XYZ to largely replace the original loan, but they contrive to get legal terms for that new loan that give it a higher priority for payment than the original loan. This is called “up-tiering” the new loan.  This has the effect of reducing the market value of the original loan.

Lender C is now hosed. It faces murky prospects for repayment on that original loan. Lenders A and B offer to buy them out of the original loan for 40 cents on the dollar. Lender C proceeds to sue Lenders A and B.

Will Lender C prevail? Probably not, if the course of recent cases is any guide. Unless there is very specific language in the legal “covenant” regarding the first loan forbidding this practice, it seems to be legal.

A similar maneuver would be for a new Lender D to offer a replacement loan to Company XYZ, with legal language giving it priority over the original loan. This is called “priming.”

Yet another tactic by the aggressive lenders includes working with Company XYZ to move its more valuable assets into a subsidiary or shell company, and to get the new loan to hold that as collateral. This again hoses the “victim” lenders, since again the assurance that they will be repaid has gone down.

My Personal Experience with Lender-on-Lender Violence

Some years ago, I bought the bonds of a company called SeaDrill. I bought the bonds instead of the common or preferred stock, for an additional margin of safety. Unlike the stock, the bonds must be repaid in full, right? Both the bonds and the preferreds were paying about 9%, back when general interest rates were much lower than that are now. So, I was a lender to the company.  

Silly me. Times got tough in the oil patch, and the company would have had difficulty paying off its bonds AND paying its management their high salaries. So, they went for Chapter 11 bankruptcy. I had not realized the difference between Chapter 7 bankruptcy, where the company shuts down and liquidates and pays off its creditors in pecking order, and Chapter 11, which is largely a chance for the company to put the losses on its creditors and to keep on operating.

As with the example above, some big institution offered to refinance things with new secured bonds that had priority ahead of the old bonds (which I held). In the end I got about 44 cents on the dollar for my bonds. I was not happy about that, but I did make out better than the hapless preferred stockholders, who got just a tiny crumb to make them go away. It was a learning experience. I did feel, well, violated.

Implications for the Burgeoning Private Credit Market

I will be writing more on the booming “private credit” market. Many of the loans in this space are “covenant-lite.” Back before say 2008, a large fraction of loans to business were through banks, who would insist on strong legal protection for their money. But in recent years, private equity funds have competed for this lending, allowing the borrowers to borrow on terms that give much less protection to the lenders. Cov-lite is now the norm.

Traditionally, loans (as distinct from bonds) to businesses have enjoyed decent recoveries (e.g., around 70%) in case of defaults, thanks to strong collateral backing the loans. But if we face any sort of prolonged recession and elevated defaults, the recoveries on all these loans will be far less than in the past. These are uncharted waters.

A Reference for “Lender-on-Lender Violence”

A solid description  of these matters is found in “ Uptier Transactions and Other Lender-on-Lender Violence: The Potential for More Litigation and Disputes on the Horizon “ at dailydac.com.

The Calming Psychology of Money

James Bailey2 Comments

Morgan Housel’s Psychology of Money is not much like other personal finance books. Rather than making recommendations about exactly what to do and how to do it, Housel tells stories about how people’s different attitudes toward money serve them well or poorly. His stance is that most people already know what they should do, so he doesn’t need to explain that, but instead needs to explain why people so often don’t do what they know they should (e.g. save more). The book is not only pleasant to read, but at least for me exerts a calming effect I definitely do not normally associate with the finance genre, as if the subtext of “just be chill, be patient, follow the plan and everything will be alright” is continually seeping into my brain. Some highlights:

The idea of retirement is fairly new. Labor force participation for men over 65 is only about 20% today, but was well over 50% prior to the introduction of Social Security. Even once it started, Social Security paid in real terms about a quarter of what it does today. Plus pensions weren’t as common as people think; as of 1975 only a quarter of those over 65 had pensions, and most of those didn’t pay much. The 401k didn’t exist until 1978; the Roth IRA until 1998. “It should surprise no one that many of us are bad at saving and investing for retirement. We’re not crazy. We’re all just newbies.”

If you are disappointed whenever the price of your stocks goes down, you are in for a bad time, though you will do well if you can just ignore it:

“Netflix stock returned more than 35,000% from 2002 to 2018, but traded below its previous all-time high on 94% of days. Monster Beverage returned 319,000% from 1995 to 2018- among the highest returns in history- but traded below its previous high 95% of the time during that period…. this is the price of market returns.”

Housel isn’t very prescriptive because he recognizes how much people differ: “I can’t tell you what to do with your money, because I don’t know you. I don’t know what you want. I don’t know when you want it. I don’t know why you want it.”

At the end explains what he does with his own money: “Effectively all of our net worth is a house, a checking account, and some Vanguard index funds.” He convincingly argues that his way isn’t for everyone; he paid off his house early but “I don’t try to defend this decision to those pointing out its flaws, or to those who would never do the same. On paper it’s defenseless. But it works for us. We like it. That’s what matters.”

The closest he gets to specific recommendation is “for most investors, dollar-cost averaging into a low-cost index fund will provide the highest odds of long-term success.” There are lots of more general recommendations about good mindsets to take, for instance:

The few people who know the details of our finances ask, ‘What are you saving for? A house? A boat? A new car?’ No, none of those. I’m saving for a world where curveballs are more common than we expect.

Overall this is an easy book to recommend- it is both pleasant and easy to read, and gives good advice. My main complaint is that it is short on the nuts and bolts of how you actually do this stuff; for someone who doesn’t already know, it would pair well with a book that is stronger on that front, like I Will Teach You to Be Rich.

Future Consumption Has Never Been Cheaper

Zachary Bartsch1 Comment

Economics as a discipline really likes to boil things down to their essentials. There are plenty of examples. How many goods can one consume? Just two, bread and not bread. How can you spend your time? You can labor or leisure. How do you spend your money? Consume or save. It’s this last one that I want to emphasize here.

First, all income ultimately ends up being spent on consumption. Saving today is just the decision to consume in the future. And if not by you, then by your heirs. One determinant of inter-temporal consumption decisions is the real rate of return. That is, how many apples can you eat in the future by forgoing an apple eaten today? The bigger that number is, the more attractive the decision to save.

Further, since most saving is not in the form of cash and is instead invested in productive assets, we can also characterize the intertemporal consumption problem as the current budget allocation decision to consume or invest. The more attractive capital becomes, the more one is willing to invest rather than consume. The relative attractiveness between consumption and investment informs the consumption decision.

How attractive is investment? I’ll illustrate in two graphs. First, if the price of investment goods falls relative to consumption goods, then individuals will invest more. The graph below charts the price ratio of investment goods to consumption goods. Relative to consumption, the price of investment has fallen since 1980. Saving for the future has never been cheaper!

https://fred.stlouisfed.org/graph/?g=1p0C7

Of course, as in a price taker story, I am assuming that individuals don’t affect this price ratio. Truly, prices are endogenous to consumption/investment decisions. For all we know, it may be that the prices of investment goods are falling because demand for investment goods has fallen. But that doesn’t appear to be the case.

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Woodstock for Nerds: Highlights from Manifest

James Bailey4 Comments

I’m back from Manifest, a conference on prediction markets, forecasting, and the future. It was an incredible chance to hear from many of my favorite writers on the internet, along with the CEOs of most major prediction markets; in Steve Hsu’s words, Woodstock for Nerds. Some highlights:

Robin Hanson took over my session on academic research on prediction markets (in a good way; once he was there everyone just wanted to ask him questions). He thinks the biggest current question for the field is to figure out why is the demand for prediction markets so low. What are the different types of demand, and which is most likely to scale? In a different talk, Robin says that we need to either turn the ship of world culture, or get off in lifeboats, before falling fertility in a global monoculture wrecks it.

Play-money prediction markets were surprisingly effective relative to real-money ones in the 2022 midterms. Stephen Grugett, co-founder of Manifold (the play-money prediction market that put on the conference), admitted that success in one election could simply be a coincidence. He himself was surprised by how well they did in the 2022 midterms, and said he lost a bunch of mana on bets assuming that Polymarket was more accurate.

Substack CEO Chris Best: No one wants to pay money for internet writing in the abstract, but everyone wants to pay their favorite writer. For me, that was Scott Alexander. We are trying to copy Twitter a bit. Wants to move into improving scientific publishing. I asked about the prospects of ending the feud with Elon; Best says Substack links aren’t treated much worse than any other links on X anymore.

Razib Khan explained the strings he had to pull for his son to be the first to get a whole genome sequence in utero back in 2014- ask the hospital to do a regular genetic test, ask them for the sample, get a journalist to tweet at them when they say no, get his PI’s lab to run the sample. He thinks crispr companies could be at the nadir of the hype cycle (good time to invest?).

Kalshi cofounder Luana Lopes Lara says they are considering paying interest on long term markets, and offering margin. There is enough money in it now that their top 10 or so traders are full time (earning enough that they don’t need a job). The CFTC has approved everything we send them except for once (elections). We don’t think their current rule banning contest markets will go through, but if it does we would have to take down Oscar and Grammy markets. When we get tired of the CFTC, we joke that we should self certify shallot futures markets (toeing the line of the forbidden onion futures). Planning to expand to Europe via brokerages. Added bounty program to find rules problems. Launching 30-50 markets per week now (seems like a good opportunity, these can’t all be efficient right?).

There was lots else of interest, but to keep things short I’ll just say it was way more fun and informative doing yet another academic conference, where I’ve hit diminishing returns. More highlights from Theo Jaffee here; I also loved economist Scott Sumner’s take on a similar conference at the same venue in Berkeley:

If you spend a fair bit of time surrounded by people in this sector, you begin to think that San Francisco is the only city that matters; everywhere else is just a backwater. There’s a sense that the world we live in today will soon come to an end, replaced by either a better world or human extinction. It’s the Bay Area’s world, we just live in it.

Is the Monster Jobs Report Just a Head-Fake?

Scott Buchanan2 Comments

Financial markets have sustained themselves for nearly two years now on the hope that within 1-2 quarters, the Fed will finally relent and start lowering interest rates. This hope gets dashed again and again by data showing stubbornly persistent high employment, high GDP growth, and high inflation, but the hope refuses to die.

Long-term interest rates had been falling nicely for the last month, based on expectations of rate cuts in the fall. Then came Friday’s jobs report, and, blam, up went 10-year rates again.  The Bureau of Labor Statistics (BLS) published its “Establishment” survey of data gleaned from employers. Non-farm payrolls rose by US 272k.  This was appreciably higher than the 180k consensus expectation.

The plot below indicates that this number fits into a trend of essentially steady, fairly high employment gains (suggesting ongoing inflationary pressures):

There are fundamental reasons to take the BLS Establishment figures with a grain of salt. They have a history of significant revisions some months after first publication. Also, BLS uses a  “birth/death” model for small businesses, which can account for some 50% (!) of the job gains they report.  [1]

Another factor is that all of the net “jobs” created in recent quarters are reported to be part-time. According to Bret Jensen at Seeking Alpha, “Part-time jobs rose 286,000 during the quarter, while full-time jobs fell by just over 600,000. This is a continuation of a concerning trend where over the past year, roughly 1.5 million part-time positions were created while approximately one million full-time jobs were lost. This difference is that the BLS survey does not account for people working two or three jobs, which are now at a record as many Americans have struggled to maintain their standard of living during the inflationary environment of the past couple of years.”

It seems, then, that this week’s huge “jobs added” figure is not to be taken as indicating that the economy is overheated. However, it is still warm enough that rate cuts will be postponed yet again. A different BLS survey (“Household”) showed unemployment creeping up from 4.0% to 4.1%, which again suggests a more or less steady and fairly robust employment picture.

As far as drivers of inflation, I would look especially at wage growth. That is fitfully slowing, but not nearly enough to get us to the Fed’s 2% annual inflation target. My sense is that ongoing enormous federal deficit spending will keep pumping money into the economy fast enough to keep inflation high. High inflation will prevent significant interest rate cuts, assuming the Fed remains responsible. The interest payments on the federal debt will balloon due to the high rates, leading to even more deficit spending.  If we actually get an economic downturn, leading to job insecurity and a willingness of workers to accept slower wage growth in the private sector, the federal spending floodgates will open even wider.

This makes hard assets like gold look attractive, to hedge against inflating U.S. dollars. This is one reason China has been quietly selling off its dollar hoard, and buying gold instead.

[1] For more in-depth treatments of employment statistics, see posts by fellow blogger Jeremy Horpedahl, e.g. here.

Corporate Landlords Make Rent… Lower?

Zachary Bartsch6 Comments

Let’s keep it brief. Stick with me.

You know how perfect diversification means that one bears no idiosyncratic risk? That means that one is willing to pay more for some given return, driving up the price of assets included in such a diversified portfolio. That means that, without an informational advantage, index funds should place upward pressure on the price of assets that compose them. Anyone who invests in individual stocks, again without an informational advantage, would be priced out of the market because they bear idiosyncratic risk and would need to enjoy a risk premium that lowers the maximum price that they are willing to pay.

What about real estate?

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