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What laypeople need to realize is the following relation: Low federal funds rates allow companies to acquire huge amounts of debt very cheaply. Huge amounts o

What laypeople need to realize is the following relation: Low federal funds rates allow companies to acquire huge amounts of debt very cheaply. Huge amounts of cheap debt allow companies to buy lots of stock, driving up prices. Stock prices inflated in such a way are not supported by fundamentals and so the downside risk greatly increases. Once the downside eventually materializes, markets drop violently. At first, the FED ignores this, but eventually it bails. The funds rate is once again lowered, so the game can continue. In any event, the game must continue, because companies need new debt to service old debt. If the new debt was more expensive, the companies would eventually risk defaulting. To understand the risk of corporate defaults, one must look at the importance of corporate bonds in pension funds. Ironically, the low federal funds rate is part of what drives pension funds to purchase more risky corporate debt, in order to meet their yield requirements. All of this causes massive asset price inflation. Stock prices are detached from actual revenue, real estate prices are detached from rent income. The rich are getting richer - at least on paper - because they own most of the assets. The CPI doesn't immediately reflect this kind of inflation, so the FED gets to claim "there is no inflation" and everything is "just fine". Well, it's not fine and they know it, they just can't really do anything about it.

SpicyLemonZest 7y ago
It's hard for me to see why this dynamic would happen. What specific federal funds rate would make stock prices "supported by fundamentals" rather than "inflated", and why in your view can't the Fed just set that rate to avoid these problems?
- unimployed 7y ago
  Because a mix of globalization, technological financialization, and perverse incentives. The markets have become increasingly global to the point that there is never a shortage of investors or investment capital. However, profitable, low or no risk investment opportunities do not grow on trees nearly as plentifully. Due to an overabundant supply of investors with a high demand to seek profitable low or no risk investment opportunities to park their wealth for growth via interest, and a much lower supply of profitable low or no risk investment opportunities—the interest rates to park your wealth must fall. And they have fallen quite steadily and predictably since their peak in the 1970s and 1980s... which nicely corresponds with the technological globalization and financialization of markets and marks their triumph over inflation (why inflation has not returned). There is another reason for inflated asset prices besides cheap interest rates. Many assets are also priced to interest rates in an inverted fashion (for bonds, that is exactly the formula how they work and are priced). Just before the recession, stock buy-backs were no longer prohibited and since the great recession and the ultra low interest rate environment coupled with stock buy-backs, stocks have become a slightly more risky alternative to bonds and stock prices became just as inflated as bonds and have more or less stayed that way. You see, when you have a combination of all those factors coupled with the ability to buy back your stock, stocks are now able to compete almost directly with bonds for investors and stock prices inflate accordingly. Because globalization, technology, and financialization happen much faster than markets and regulation can respond, and there are vested interests by investors (corporations, banks, Wall Street, etc.) to maintain the status quo via lobbying the politicians and regulators... the situation is unlikely to resolve itself via some self-regulating efficient market hypothesis.
  - cat199 7y ago
    > Due to an overabundant supply of investors with a high demand to seek profitable low or no risk investment opportunities to park their wealth for growth via interest, and a much lower supply of profitable low or no risk investment opportunities—the interest rates to park your wealth must fall. Or, lowering interest rates creates overabundant demand for low/no risk investment opportunities... while I agree with your analysis, it's only valid for 1 side of the coin - similarly, this all also 'nicely corresponds' with the rise of supply-side / trickle-down economics as well.. as for inflation: is not a growth in wage disparity just as good of a measure of relative inflation over time as some small and continually modified basket of consumer goods?
    - unimployed 7y ago
      It’s what seems to make sense. Lower relative interest rates creating the overabundant demand doesn’t seem to carry as much explanatory power when you consider that interest rates were also relatively lower before the hyper-inflationary period. What changed is not just the interest rates being lower. True lower rates have some effect, it’s just not enough when you consider that the investments will also be lower growth. Supply side economics has a hand to play here, already mentioned in deregulation, lobbying by corporate interests, decreasing tax-rates on corporations and the wealthy, financial sophistication and technology of said parties to avoid taxation and capture more of the economic progress. I guess the issue is with supply side... that it is very much USA centrist and is not entirely explanatory globally. The USA does have the world’s reserve currency though. But take Japan for instance, it started the trend of low interest rates and QE forever because of globalization issues with currencies and economies, not supply side economics. I think supply side movement isn’t really incompatible with my explanation and it actually fits inside it instead of my explanation fitting inside supply side changes. I think it is helpful to remember that the neoliberal economic and libertarian agendas are responsible for all of this in any event. Income inequality is another issue... economic progress for the laborers being incremental at best while the progress of capital owners has been explosive. There is a tie-in possibly, that the income share of labor is being hallowed (or crowded) out by capital. That the economy is making laborer and consumer activity highly irrelevant in the grand scheme of things. The economy is more concerned now about retaining capital that be can pulled out en mass on a whim and major investments can be postponed on an indefinite basis for years until the conditions are capital-perfect again. The relevance of consumption is diminishing and laborers and consumers are increasingly living in an economy that is not concerned with balancing the affordability of housing and education and health care with how the rest of the economy is performing... especially the items that are rather inelastic and you require to live or progress.
- marcosdumay 7y ago
  > What specific federal funds rate would make stock prices "supported by fundamentals" rather than "inflated" Well, zero is kind of a special number. Anything significantly different from zero should create a very different dynamic (with a hyperbolic reaction of the market the closer you get to zero). That said, the stock market is never "supported by fundamentals" like the GP wants. Also, just because the interest rate is low, it does not mean that all companies are under water. Besides, I don't think anybody already knows the consequences of zero interest rates well enough to say with certainty that it's bad, but it's different from non-zero.
- gridlockd 7y ago
  > What specific federal funds rate would make stock prices "supported by fundamentals" rather than "inflated", and why in your view can't the Fed just set that rate to avoid these problems? If I could conceive of a way of calculating the optimal federal funds rate, I'd be owed a nobel prize in both economics and physics. Even then, the Fed probably wouldn't listen to my advice.
mruts 7y ago
Absolutely spot on. Banks love inflation because it allows them to arbitrage between the CPI and the rest of the economy. Also the higher inflation, the more valuable a bank's services become.
- jnordwick 7y ago
  What? Inflation means debtors make out comparative to creditors since they get to pay debt back in less expensive dollars. Banks are usually the creditor.
  - mruts 7y ago
    Well consider the clipper ship example. There was huge inflation in gold prices during the gold rush on the West coast. When the gold reached the East coast financial markets, the price of gold goes up there as well. So the key to making money was latency arbitrage between the East and West coast with fast ships. This allowed the owners to capture the delay between gold prices. Banks do the same thing. Inflation is like a cone of molasses that is being pored on the banks. It then slowly expands. So banks get the cheap money first and lend it to people that haven’t been hit with inflation yet. If they do this fast enough, they make money off arbitraging the inflation rates. Of course, the CPI doesn’t capture any of this.
    - jnordwick 7y ago
      The price of gold up until the 1920s was pretty stable sub-$19 - even below the government's fixed rate. As far as I understood, the gold rush had very little impact on the price of gold. But I also think this confuses topics. You are just talking straight up arbitrage that has nothing to do with being a bank. That arbitrage from high supply area to low suppy area will lower the price. The arbitrager makes some money on the transactions, but the net effect is to push the price down. Not that great for the huge socks on loans already on the banks balance sheets. While the way the Fed operates, currency enters our economy through bank deposits turned into loans (not as true as it once was in the post QE world) those loans are going to be repaid 5+ years when inflationary effects have already started pushing the dollars down that they are being paid back in. Plus, the point of the extra reserves is to drive down rates since there will be a greater supply. They get hosed in both ways.
mrep 7y ago
CPI includes rent which has gone up 2.7% per year averaged out since 2008 [0]. I wouldn't call that extreme. As for stocks, the S&P 500 P/E ratio is about 20 which is pretty much average for recent times [1]. [0]: https://fred.stlouisfed.org/series/DTENRX1A020NBEA https://fred.stlouisfed.org/series/DTENRX1A020NBEA [1]: https://www.macrotrends.net/2577/sp-500-pe-ratio-price-to-earnings-chart https://www.macrotrends.net/2577/sp-500-pe-ratio-price-to-ea...
- gridlockd 7y ago
  > CPI includes rent Yes, but rent didn't increase the same way as property prices, which is what makes those properties overvalued in the first place. Also, averages are misleading. Of course people will first buy property in "good" areas, not "average" areas. If you look at rent or property price development in San Francisco, you will notice that. > As for stocks, the S&P 500 P/E ratio is about 20 which is pretty much average for recent times [1] The CAPE is at 30, double the historic average and higher than at the top of the bubble in 1929 and every year since then up until the dotcom bubble. Again, averages are misleading. All you can say is that we haven't reached dotcom levels of valuation yet. https://www.multpl.com/shiller-pe https://www.multpl.com/shiller-pe
criddell 7y ago
Are there buyback limits? Is it possible that company could buy all of it's stock?
- Jabbles 7y ago
  This is known as "going private". https://www.investopedia.com/terms/g/going-private.asp https://www.investopedia.com/terms/g/going-private.asp One example is Dell: https://en.wikipedia.org/wiki/Dell#2013_buyout https://en.wikipedia.org/wiki/Dell#2013_buyout Also see Elon Musk's infamous tweet about Tesla: https://en.wikipedia.org/wiki/Tesla,_Inc.#Securities_Litigation_related_to_Potential_Going_Private_Transaction https://en.wikipedia.org/wiki/Tesla,_Inc.#Securities_Litigat...
  - criddell 7y ago
    So a company that has gone private isn't owned by another entity? There are no external stakeholders?
    - kgwgk 7y ago
      Silver Lake (a private equity firm) took Dell private in 2013. Interestingly, the company didn’t use buybacks to become private but it did use buybacks to become public again last year [1]. It was done by buying back some piece of its business that remained traded in the stock exchange following the acquisition of EMC when Dell was private [2]. [1] https://www.techspot.com/news/77848-dell-about-go-public-second-time.html https://www.techspot.com/news/77848-dell-about-go-public-sec... [2] https://www.bloomberg.com/opinion/articles/2015-10-13/dell-will-issue-a-lot-of-not-quite-stock-to-pay-for-emc https://www.bloomberg.com/opinion/articles/2015-10-13/dell-w...
- deleted 7y ago
  [deleted]
- kgwgk 7y ago
  Not all of it, I think. (At least I don’t think reducing outstanding shares to 0 is a well-defined process, I could be wrong.) But theoretically if a company do keep buying its own shares it can reduce their number to the point where the company is no longer required to be “public” and the shares can be delisted. However the important number is how many shareholders the company has, not how many shares (but obviously a company with 300 shares cannot have more than 300 shareholders). I don’t know if that has ever happened. Reducing the numbers of shares (and shareholders) can also be done be reverse splitting. For example a company that is doing so badly that the share price goes to zero and regularly do inverse splits (making one $5 share from 100 $0.05 shares) will end up with a handful of shares. Or a company which is not failing may try to get rid of minority shareholders by doing reverse splits (if you don’t have enough shares to get the new one you get cash instead). The usual way to reduce the number of shareholders is for someone to make a tender offer. And in that case there are rules about what happens with those who didn’t choose to sell. That’s what happened with Dell, that another comment mentioned, which was bought by Silver Lake. https://www.sec.gov/fast-answers/answersgoprivhtm.html https://www.sec.gov/fast-answers/answersgoprivhtm.html
lbotos 7y ago
I, lay person here, to see if I get it: > Huge amounts of cheap debt allow companies to buy lots of stock, driving up prices. > Stock prices inflated in such a way are not supported by fundamentals and so the downside risk greatly increases. The price is driven up by "demand" but the demand is not "real" because it wasn't due to the business actually _innovating_ but actually just "stock changing hands"? > Once the downside eventually materializes, markets drop violently. At first, the FED ignores this, but eventually it bails. The funds rate is once again lowered, so the game can continue. When/how does that happen? > All of this causes massive asset price inflation. There is no way for it to "not" right? It's sort of like measuring volume of action, but the action didn't actually produce any real "value"? > The CPI doesn't immediately reflect this kind of inflation, so the FED gets to claim "there is no inflation" and everything is "just fine". Well, it's not fine and they know it, they just can't really do anything about it. Is there a better measure that _does_ reflect it? It sounds like it can be modeled with corporate debt / buyback on a graph? Again, layperson here, hoping to learn stuff.
- streetcat1 7y ago
  You will not see market dropping or any sudden move. Basically there is no alternative to risk (the riskless rate will drop below 0) . There will also be no inflation (maybe deflation due to the increasing part of software in products)
- gridlockd 7y ago
  > The price is driven up by "demand" but the demand is not "real" because it wasn't due to the business actually _innovating_ but actually just "stock changing hands"? The demand is real, but the fundamentals do not support it. Fundamentals include things like price vs. earnings or debt vs. assets, dividend yields, etc. If you like at this graph of price vs. earnings, you can can see dramatic rises relating to stock market bubbles: https://www.multpl.com/shiller-pe https://www.multpl.com/shiller-pe > When/how does that happen? It has already happened and we're in the middle of it. When the markets tanked in late 2018, the Fed stopped hiking. When the markets tanked again in May, the Fed announced a rate cut. Now that the rate cut is in place, the markets are tanking again, perhaps because a bigger rate cut was priced in. We'll see what happens in the coming months. > There is no way for it to "not" right? It's sort of like measuring volume of action, but the action didn't actually produce any real "value"? I guess that's a fair way of looking at it. > Is there a better measure that _does_ reflect it? Of course there are indicators that you can use to show that this kind of inflation is taking place, like the S&P 500 PE ratio I showed earlier, or rent income vs. property prices.
jnordwick 7y ago
The overnight rate does not effect real long term rates, they are fucking inverted. Real rates are set by return on capital (plus inflation for nominal rates) in the long end. Pensions and retirement funds are only affected by the overnight rates in so much they use hold short term reserves as cash equivalents. > Stock prices inflated in such a way are not supported by fundamentals Inflation - what your describing, more dollars chasing same production - is a fundamental factor and doesn't affect rate of return in the time scales you are talking about. > All of this causes massive asset price inflation. Stock prices are detached from actual revenue, No, then there would be an arbitrage opportunity (if you so easily see it obviously the smart, deep pocketed money would see it too). Stock prices are still set by future income streams but now that is nominally pumped by inflation so they are bid up. Since equity prices are forward looking their prices rise faster than the backwards looking cpi. There really isn't a lot of extra dollars sloshing around though. All the forward looking indexes of inflation are down: commodity crb index, metals index (including gold), tips spreads - all down in the last six months.
- gridlockd 7y ago
  > The overnight rate does not effect real long term rates, they are fucking inverted. The federal funds rate greatly affects credit rates, that's why it's a primary instrument in financial policy. > Pensions and retirement funds are only affected by the overnight rates in so much they use hold short term reserves as cash equivalents. That's the direct effect, but because all other credit rates are affected, so are corporate bonds, which are a major component of pension fund allocations. > All the forward looking indexes of inflation are down: commodity crb index, metals index (including gold), tips spreads - all down in the last six months. > No, then there would be an arbitrage opportunity (if you so easily see it obviously the smart, deep pocketed money would see it too). Why? Who says that prices aren't going to stay "permanently inflated"? I'm talking about downside risk, not a guaranteed and easily timed market selloff. > All the forward looking indexes of inflation are down: commodity crb index, metals index (including gold), tips spreads - all down in the last six months. Sure, if you look at commodities, there is no inflation. If you look at the CPI, there is no inflation. It depends on where you look. Gold is way up though, regardless of what the index says.
crumpets 7y ago
None of this is how this stuff works. >Huge amounts of cheap debt allow companies to buy lots of stock, driving up prices. Companies don't use debt to buy stock. Taking on the debt to do that would depress the stock price the same amount that the buying would attempt to appreciate it. >All of this causes massive asset price inflation. This would be reflected in the CPI. >Stock prices are detached from actual revenue No they aren't. See UBER/LYFT/AAPL. >so the FED gets to claim "there is no inflation" The Fed does not claim that. They claim inflation is nominal near their intended target. Finally, stop saying FED. It's not an acronym.
- kgwgk 7y ago
  > Companies don't use debt to buy stock. Sure they do. Edit: https://www.bloomberg.com/news/articles/2019-08-08/companies-use-borrowed-billions-to-buy-back-stock-not-to-invest https://www.bloomberg.com/news/articles/2019-08-08/companies... By the way, the claim “Taking on the debt to do that would depress the stock price“ doesn’t seem correct. The influence of leverage on valuation is complex and depends on the cost of debt and equity, tax shielding considerations, the increase in risk due to the financial leverage... and essentially on what the money is going to be used for.
  - rbavocadotree 7y ago
    All the time in fact. There's been $5 trillion in stock buybacks by US companies in the last decade. Most of it through leveraged buybacks. It often makes more sense to use debt than cash for buybacks.
- gridlockd 7y ago
  > None of this is how this stuff works. If you make that claim, you should do some actual debunking instead of just nitpicking. > Companies don't use debt to buy stock. Yes, they do. > Taking on the debt to do that would depress the stock price the same amount that the buying would attempt to appreciate it. Maybe if valuation was strictly tied to fundamentals, which it isn't. > This would be reflected in the CPI. Eventually it will be, but that can take a while, because many of the prices involved in the CPI are sticky. > No they aren't. See UBER/LYFT/AAPL. I'm sorry, I meant to write "profits" there. Sure, UBER and LYFT may have a lot of revenue, but they're losing a lot of money in the process. I wouldn't say Apple is overvalued, but clearly the market is taking its lack of growth prospects unkindly. > The Fed does not claim that. They claim inflation is nominal near their intended target. Fair enough, to be precise, that is what they are saying, and what I mean by "no inflation (to worry about)". > Finally, stop saying FED. It's not an acronym. I'm aware of that, but I think it looks better this way. If writing it that way annoys just one nitpicker on the internet, it's worth it.
nabla9 7y ago
That's very unicausal explanation that puts all blame for Fed. The truth is that there are trends increase stock prices independent of Fed. The secular decline in real interest rates over almost 40 years is global phenomenon. Increasing demand for safe and liquid assets and decline in world economic growth might be factors. In the US the amount of money in mutual funds, hedge funds, ETFs, insurance companies, 401Ks etc has exploded while supply has decreased. The number of listed stocks in US markets has dropped dramatically. This is genuine change in supply and demand.
- gridlockd 7y ago
  > That's very unicausal explanation that puts all blame for Fed. That's a fair point and that wasn't my intention, but you can only fit so much context into a comment. I'm not even saying they're "doing it wrong", but that they are in a pickle. Of course interest rates are low globally and it's not just domestic capital bidding up prices. > In the US the amount of money in mutual funds, hedge funds, ETFs, insurance companies, 401Ks etc has exploded while supply has decreased. Well alright, but why has it exploded? Why do all these allocations into riskier asset classes take place? Is it all just greed, or is it the interest rate environment?

SpicyLemonZest 7y ago

It's hard for me to see why this dynamic would happen. What specific federal funds rate would make stock prices "supported by fundamentals" rather than "inflated", and why in your view can't the Fed just set that rate to avoid these problems?

unimployed 7y ago
Because a mix of globalization, technological financialization, and perverse incentives. The markets have become increasingly global to the point that there is never a shortage of investors or investment capital. However, profitable, low or no risk investment opportunities do not grow on trees nearly as plentifully. Due to an overabundant supply of investors with a high demand to seek profitable low or no risk investment opportunities to park their wealth for growth via interest, and a much lower supply of profitable low or no risk investment opportunities—the interest rates to park your wealth must fall. And they have fallen quite steadily and predictably since their peak in the 1970s and 1980s... which nicely corresponds with the technological globalization and financialization of markets and marks their triumph over inflation (why inflation has not returned). There is another reason for inflated asset prices besides cheap interest rates. Many assets are also priced to interest rates in an inverted fashion (for bonds, that is exactly the formula how they work and are priced). Just before the recession, stock buy-backs were no longer prohibited and since the great recession and the ultra low interest rate environment coupled with stock buy-backs, stocks have become a slightly more risky alternative to bonds and stock prices became just as inflated as bonds and have more or less stayed that way. You see, when you have a combination of all those factors coupled with the ability to buy back your stock, stocks are now able to compete almost directly with bonds for investors and stock prices inflate accordingly. Because globalization, technology, and financialization happen much faster than markets and regulation can respond, and there are vested interests by investors (corporations, banks, Wall Street, etc.) to maintain the status quo via lobbying the politicians and regulators... the situation is unlikely to resolve itself via some self-regulating efficient market hypothesis.
- cat199 7y ago
  > Due to an overabundant supply of investors with a high demand to seek profitable low or no risk investment opportunities to park their wealth for growth via interest, and a much lower supply of profitable low or no risk investment opportunities—the interest rates to park your wealth must fall. Or, lowering interest rates creates overabundant demand for low/no risk investment opportunities... while I agree with your analysis, it's only valid for 1 side of the coin - similarly, this all also 'nicely corresponds' with the rise of supply-side / trickle-down economics as well.. as for inflation: is not a growth in wage disparity just as good of a measure of relative inflation over time as some small and continually modified basket of consumer goods?
  - unimployed 7y ago
    It’s what seems to make sense. Lower relative interest rates creating the overabundant demand doesn’t seem to carry as much explanatory power when you consider that interest rates were also relatively lower before the hyper-inflationary period. What changed is not just the interest rates being lower. True lower rates have some effect, it’s just not enough when you consider that the investments will also be lower growth. Supply side economics has a hand to play here, already mentioned in deregulation, lobbying by corporate interests, decreasing tax-rates on corporations and the wealthy, financial sophistication and technology of said parties to avoid taxation and capture more of the economic progress. I guess the issue is with supply side... that it is very much USA centrist and is not entirely explanatory globally. The USA does have the world’s reserve currency though. But take Japan for instance, it started the trend of low interest rates and QE forever because of globalization issues with currencies and economies, not supply side economics. I think supply side movement isn’t really incompatible with my explanation and it actually fits inside it instead of my explanation fitting inside supply side changes. I think it is helpful to remember that the neoliberal economic and libertarian agendas are responsible for all of this in any event. Income inequality is another issue... economic progress for the laborers being incremental at best while the progress of capital owners has been explosive. There is a tie-in possibly, that the income share of labor is being hallowed (or crowded) out by capital. That the economy is making laborer and consumer activity highly irrelevant in the grand scheme of things. The economy is more concerned now about retaining capital that be can pulled out en mass on a whim and major investments can be postponed on an indefinite basis for years until the conditions are capital-perfect again. The relevance of consumption is diminishing and laborers and consumers are increasingly living in an economy that is not concerned with balancing the affordability of housing and education and health care with how the rest of the economy is performing... especially the items that are rather inelastic and you require to live or progress.
marcosdumay 7y ago
> What specific federal funds rate would make stock prices "supported by fundamentals" rather than "inflated" Well, zero is kind of a special number. Anything significantly different from zero should create a very different dynamic (with a hyperbolic reaction of the market the closer you get to zero). That said, the stock market is never "supported by fundamentals" like the GP wants. Also, just because the interest rate is low, it does not mean that all companies are under water. Besides, I don't think anybody already knows the consequences of zero interest rates well enough to say with certainty that it's bad, but it's different from non-zero.
gridlockd 7y ago
> What specific federal funds rate would make stock prices "supported by fundamentals" rather than "inflated", and why in your view can't the Fed just set that rate to avoid these problems? If I could conceive of a way of calculating the optimal federal funds rate, I'd be owed a nobel prize in both economics and physics. Even then, the Fed probably wouldn't listen to my advice.

mruts 7y ago

Absolutely spot on. Banks love inflation because it allows them to arbitrage between the CPI and the rest of the economy. Also the higher inflation, the more valuable a bank's services become.

jnordwick 7y ago
What? Inflation means debtors make out comparative to creditors since they get to pay debt back in less expensive dollars. Banks are usually the creditor.
- mruts 7y ago
  Well consider the clipper ship example. There was huge inflation in gold prices during the gold rush on the West coast. When the gold reached the East coast financial markets, the price of gold goes up there as well. So the key to making money was latency arbitrage between the East and West coast with fast ships. This allowed the owners to capture the delay between gold prices. Banks do the same thing. Inflation is like a cone of molasses that is being pored on the banks. It then slowly expands. So banks get the cheap money first and lend it to people that haven’t been hit with inflation yet. If they do this fast enough, they make money off arbitraging the inflation rates. Of course, the CPI doesn’t capture any of this.
  - jnordwick 7y ago
    The price of gold up until the 1920s was pretty stable sub-$19 - even below the government's fixed rate. As far as I understood, the gold rush had very little impact on the price of gold. But I also think this confuses topics. You are just talking straight up arbitrage that has nothing to do with being a bank. That arbitrage from high supply area to low suppy area will lower the price. The arbitrager makes some money on the transactions, but the net effect is to push the price down. Not that great for the huge socks on loans already on the banks balance sheets. While the way the Fed operates, currency enters our economy through bank deposits turned into loans (not as true as it once was in the post QE world) those loans are going to be repaid 5+ years when inflationary effects have already started pushing the dollars down that they are being paid back in. Plus, the point of the extra reserves is to drive down rates since there will be a greater supply. They get hosed in both ways.

mrep 7y ago

CPI includes rent which has gone up 2.7% per year averaged out since 2008 [0]. I wouldn't call that extreme. As for stocks, the S&P 500 P/E ratio is about 20 which is pretty much average for recent times [1]. [0]: https://fred.stlouisfed.org/series/DTENRX1A020NBEA https://fred.stlouisfed.org/series/DTENRX1A020NBEA [1]: https://www.macrotrends.net/2577/sp-500-pe-ratio-price-to-earnings-chart https://www.macrotrends.net/2577/sp-500-pe-ratio-price-to-ea...

gridlockd 7y ago
> CPI includes rent Yes, but rent didn't increase the same way as property prices, which is what makes those properties overvalued in the first place. Also, averages are misleading. Of course people will first buy property in "good" areas, not "average" areas. If you look at rent or property price development in San Francisco, you will notice that. > As for stocks, the S&P 500 P/E ratio is about 20 which is pretty much average for recent times [1] The CAPE is at 30, double the historic average and higher than at the top of the bubble in 1929 and every year since then up until the dotcom bubble. Again, averages are misleading. All you can say is that we haven't reached dotcom levels of valuation yet. https://www.multpl.com/shiller-pe https://www.multpl.com/shiller-pe

criddell 7y ago

Are there buyback limits? Is it possible that company could buy all of it's stock?

Jabbles 7y ago
This is known as "going private". https://www.investopedia.com/terms/g/going-private.asp https://www.investopedia.com/terms/g/going-private.asp One example is Dell: https://en.wikipedia.org/wiki/Dell#2013_buyout https://en.wikipedia.org/wiki/Dell#2013_buyout Also see Elon Musk's infamous tweet about Tesla: https://en.wikipedia.org/wiki/Tesla,_Inc.#Securities_Litigation_related_to_Potential_Going_Private_Transaction https://en.wikipedia.org/wiki/Tesla,_Inc.#Securities_Litigat...
- criddell 7y ago
  So a company that has gone private isn't owned by another entity? There are no external stakeholders?
  - kgwgk 7y ago
    Silver Lake (a private equity firm) took Dell private in 2013. Interestingly, the company didn’t use buybacks to become private but it did use buybacks to become public again last year [1]. It was done by buying back some piece of its business that remained traded in the stock exchange following the acquisition of EMC when Dell was private [2]. [1] https://www.techspot.com/news/77848-dell-about-go-public-second-time.html https://www.techspot.com/news/77848-dell-about-go-public-sec... [2] https://www.bloomberg.com/opinion/articles/2015-10-13/dell-will-issue-a-lot-of-not-quite-stock-to-pay-for-emc https://www.bloomberg.com/opinion/articles/2015-10-13/dell-w...
deleted 7y ago
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kgwgk 7y ago
Not all of it, I think. (At least I don’t think reducing outstanding shares to 0 is a well-defined process, I could be wrong.) But theoretically if a company do keep buying its own shares it can reduce their number to the point where the company is no longer required to be “public” and the shares can be delisted. However the important number is how many shareholders the company has, not how many shares (but obviously a company with 300 shares cannot have more than 300 shareholders). I don’t know if that has ever happened. Reducing the numbers of shares (and shareholders) can also be done be reverse splitting. For example a company that is doing so badly that the share price goes to zero and regularly do inverse splits (making one $5 share from 100 $0.05 shares) will end up with a handful of shares. Or a company which is not failing may try to get rid of minority shareholders by doing reverse splits (if you don’t have enough shares to get the new one you get cash instead). The usual way to reduce the number of shareholders is for someone to make a tender offer. And in that case there are rules about what happens with those who didn’t choose to sell. That’s what happened with Dell, that another comment mentioned, which was bought by Silver Lake. https://www.sec.gov/fast-answers/answersgoprivhtm.html https://www.sec.gov/fast-answers/answersgoprivhtm.html

lbotos 7y ago

I, lay person here, to see if I get it: > Huge amounts of cheap debt allow companies to buy lots of stock, driving up prices. > Stock prices inflated in such a way are not supported by fundamentals and so the downside risk greatly increases. The price is driven up by "demand" but the demand is not "real" because it wasn't due to the business actually _innovating_ but actually just "stock changing hands"? > Once the downside eventually materializes, markets drop violently. At first, the FED ignores this, but eventually it bails. The funds rate is once again lowered, so the game can continue. When/how does that happen? > All of this causes massive asset price inflation. There is no way for it to "not" right? It's sort of like measuring volume of action, but the action didn't actually produce any real "value"? > The CPI doesn't immediately reflect this kind of inflation, so the FED gets to claim "there is no inflation" and everything is "just fine". Well, it's not fine and they know it, they just can't really do anything about it. Is there a better measure that _does_ reflect it? It sounds like it can be modeled with corporate debt / buyback on a graph? Again, layperson here, hoping to learn stuff.

streetcat1 7y ago
You will not see market dropping or any sudden move. Basically there is no alternative to risk (the riskless rate will drop below 0) . There will also be no inflation (maybe deflation due to the increasing part of software in products)
gridlockd 7y ago
> The price is driven up by "demand" but the demand is not "real" because it wasn't due to the business actually _innovating_ but actually just "stock changing hands"? The demand is real, but the fundamentals do not support it. Fundamentals include things like price vs. earnings or debt vs. assets, dividend yields, etc. If you like at this graph of price vs. earnings, you can can see dramatic rises relating to stock market bubbles: https://www.multpl.com/shiller-pe https://www.multpl.com/shiller-pe > When/how does that happen? It has already happened and we're in the middle of it. When the markets tanked in late 2018, the Fed stopped hiking. When the markets tanked again in May, the Fed announced a rate cut. Now that the rate cut is in place, the markets are tanking again, perhaps because a bigger rate cut was priced in. We'll see what happens in the coming months. > There is no way for it to "not" right? It's sort of like measuring volume of action, but the action didn't actually produce any real "value"? I guess that's a fair way of looking at it. > Is there a better measure that _does_ reflect it? Of course there are indicators that you can use to show that this kind of inflation is taking place, like the S&P 500 PE ratio I showed earlier, or rent income vs. property prices.

jnordwick 7y ago

The overnight rate does not effect real long term rates, they are fucking inverted. Real rates are set by return on capital (plus inflation for nominal rates) in the long end. Pensions and retirement funds are only affected by the overnight rates in so much they use hold short term reserves as cash equivalents. > Stock prices inflated in such a way are not supported by fundamentals Inflation - what your describing, more dollars chasing same production - is a fundamental factor and doesn't affect rate of return in the time scales you are talking about. > All of this causes massive asset price inflation. Stock prices are detached from actual revenue, No, then there would be an arbitrage opportunity (if you so easily see it obviously the smart, deep pocketed money would see it too). Stock prices are still set by future income streams but now that is nominally pumped by inflation so they are bid up. Since equity prices are forward looking their prices rise faster than the backwards looking cpi. There really isn't a lot of extra dollars sloshing around though. All the forward looking indexes of inflation are down: commodity crb index, metals index (including gold), tips spreads - all down in the last six months.

gridlockd 7y ago
> The overnight rate does not effect real long term rates, they are fucking inverted. The federal funds rate greatly affects credit rates, that's why it's a primary instrument in financial policy. > Pensions and retirement funds are only affected by the overnight rates in so much they use hold short term reserves as cash equivalents. That's the direct effect, but because all other credit rates are affected, so are corporate bonds, which are a major component of pension fund allocations. > All the forward looking indexes of inflation are down: commodity crb index, metals index (including gold), tips spreads - all down in the last six months. > No, then there would be an arbitrage opportunity (if you so easily see it obviously the smart, deep pocketed money would see it too). Why? Who says that prices aren't going to stay "permanently inflated"? I'm talking about downside risk, not a guaranteed and easily timed market selloff. > All the forward looking indexes of inflation are down: commodity crb index, metals index (including gold), tips spreads - all down in the last six months. Sure, if you look at commodities, there is no inflation. If you look at the CPI, there is no inflation. It depends on where you look. Gold is way up though, regardless of what the index says.

crumpets 7y ago

None of this is how this stuff works. >Huge amounts of cheap debt allow companies to buy lots of stock, driving up prices. Companies don't use debt to buy stock. Taking on the debt to do that would depress the stock price the same amount that the buying would attempt to appreciate it. >All of this causes massive asset price inflation. This would be reflected in the CPI. >Stock prices are detached from actual revenue No they aren't. See UBER/LYFT/AAPL. >so the FED gets to claim "there is no inflation" The Fed does not claim that. They claim inflation is nominal near their intended target. Finally, stop saying FED. It's not an acronym.

kgwgk 7y ago
> Companies don't use debt to buy stock. Sure they do. Edit: https://www.bloomberg.com/news/articles/2019-08-08/companies-use-borrowed-billions-to-buy-back-stock-not-to-invest https://www.bloomberg.com/news/articles/2019-08-08/companies... By the way, the claim “Taking on the debt to do that would depress the stock price“ doesn’t seem correct. The influence of leverage on valuation is complex and depends on the cost of debt and equity, tax shielding considerations, the increase in risk due to the financial leverage... and essentially on what the money is going to be used for.
- rbavocadotree 7y ago
  All the time in fact. There's been $5 trillion in stock buybacks by US companies in the last decade. Most of it through leveraged buybacks. It often makes more sense to use debt than cash for buybacks.
gridlockd 7y ago
> None of this is how this stuff works. If you make that claim, you should do some actual debunking instead of just nitpicking. > Companies don't use debt to buy stock. Yes, they do. > Taking on the debt to do that would depress the stock price the same amount that the buying would attempt to appreciate it. Maybe if valuation was strictly tied to fundamentals, which it isn't. > This would be reflected in the CPI. Eventually it will be, but that can take a while, because many of the prices involved in the CPI are sticky. > No they aren't. See UBER/LYFT/AAPL. I'm sorry, I meant to write "profits" there. Sure, UBER and LYFT may have a lot of revenue, but they're losing a lot of money in the process. I wouldn't say Apple is overvalued, but clearly the market is taking its lack of growth prospects unkindly. > The Fed does not claim that. They claim inflation is nominal near their intended target. Fair enough, to be precise, that is what they are saying, and what I mean by "no inflation (to worry about)". > Finally, stop saying FED. It's not an acronym. I'm aware of that, but I think it looks better this way. If writing it that way annoys just one nitpicker on the internet, it's worth it.

nabla9 7y ago

That's very unicausal explanation that puts all blame for Fed. The truth is that there are trends increase stock prices independent of Fed. The secular decline in real interest rates over almost 40 years is global phenomenon. Increasing demand for safe and liquid assets and decline in world economic growth might be factors. In the US the amount of money in mutual funds, hedge funds, ETFs, insurance companies, 401Ks etc has exploded while supply has decreased. The number of listed stocks in US markets has dropped dramatically. This is genuine change in supply and demand.

gridlockd 7y ago
> That's very unicausal explanation that puts all blame for Fed. That's a fair point and that wasn't my intention, but you can only fit so much context into a comment. I'm not even saying they're "doing it wrong", but that they are in a pickle. Of course interest rates are low globally and it's not just domestic capital bidding up prices. > In the US the amount of money in mutual funds, hedge funds, ETFs, insurance companies, 401Ks etc has exploded while supply has decreased. Well alright, but why has it exploded? Why do all these allocations into riskier asset classes take place? Is it all just greed, or is it the interest rate environment?