3 ms·

ELI5: What does this mean for the economy and markets?

by spaceman_2020 3y ago

deadghost 3y ago
tl;dr: stocks go down, investors less aggressive, tech job market stays dipped US Treasury Bonds are considered the risk-free rate. If you have $TICKER that you expect to yield 5%, you wouldn't buy it because you undertake risk to invest in a company to get 5%. You'd buy a Treasury bond instead to get 5% risk-free. As a consequence, stock prices should drop until yields + premium to take on risk exceeds the risk-free rate.
- addaon 3y ago
  > If you have $TICKER that you expect to yield 5%, you wouldn't buy it because you undertake risk to invest in a company to get 5%. If the expected value of the investment is 5%, that expectation incorporates the risk. There's a chance it yields -100%, there's a chance it yields 5%, there's a chance it yields 100%, etc. If your value of money is linear, you shouldn't have a preference between a(n individual) 5% investment with high variance and one with low variance. It's perfectly reasonable to prefer low variance for a given expected return, but it's also perfectly reasonable to prefer high variance; and of course a portfolio has an expected return and variance that's a non-trivial combination (due to correlated movement) of its individual investments.
- MuffinFlavored 3y ago
  > stays dipped stays dipped or this is the beginning of the dip and continues to dip further is a fear/the fear
nine_zeros 3y ago
Debt is continuing to become more and more expensive. Lenders are not lending to people or companies unless the interest rate is much higher than the risk-free 5% offered by the US government. VCs are not getting funds from LPs who all would much rather invest in US government treasuries for the easy 5%. Public stocks are often bought with margin money (which is leverage, aka debt). Now, margin money lenders are charging a higher interest rate on that margin, causing borrowers of margin money to not borrow as much. Thus, stocks are not being bid up as much, causing stock prices to drop. Mortgage rates track the 10-year Treasury yield and thus mortgage loan rates are going higher and higher. Housing market is expected to sag, if not go into a correction or a crash. For the average person, the only parts that are affected are: 1. If their employer is dependent on cheap money (real estate, VC tech, growth stocks) these employers will either need to innovate HARD or start laying off people under pressure from investors. 2. If you were looking to borrow money for some reason (say, a house or a car), you are looking at insane interest rates. But all of this happens in any interest rate rise. What is interesting about this particular threshold of 5% is that the world hasn't seen US treasury rates at this level since the last great recession. Most companies, stock holders, people in general don't know how to evaluate this new world of a higher rate. Should you buy that car you desperately need? Is relocation for an RTO job even possible? Higher interest rates, lower investment rates can have a devastating impact on people's lives.
dragontamer 3y ago
A 5% long-term "risk free" rate is roughly equivalent to a company who makes a 'PE Ratio of 20'. Or in other terms: a $1 Billion company should be making $0.05 Billion (or $50 Million/year) in profits to be comparable to a 10Y bond at 5%. Except... everyone accepts the fact that bonds from the US Treasury (the entity that can literally print US Dollars) is lower-risk than equity from a company. (Equity is junior: if companies go bankrupt they pay their debts first and equity secondly). So you "should" be making more money from equity than bonds/debt for it to make any amount of sense. Companies will have to change their PE ratios to compete in theory. The easiest way to do this is to... lose valuation. You can't just control profits so easily, so instead of being a $1 Billion company making $50 Million/year, it'd be easier to turn into a $0.5 Billion company making $50 Million/year (now a PE Ratio of 10, or clearly better than Bonds) Or so the theory of value-investing goes. Which... doesn't really work out in reality but hopefully you get the gist. ----------- Note that dividends are meaningless from this perspective. Profits are what matters. Companies take profits an invest into themselves, so it doesn't matter if the profits are emitted as dividends (ie: $50 Million returned to the shareholders in a dividend per year), or if the company buys a new $50 million factory each year. Either way, its "the shareholders property" and therefore equivalent. If the company buys a $50 million factory each year, then in theory, they've grown by $50 million bucks. Ex: the $1 Billion company is now a $1.05 Billion company, and are expected to make $52 Million next year. After all, the "bondholder" could have spent their 5% coupon on buying more bonds, so to be "equivalent" to the risk-free bond strategy, the company also has to grow exponentially. IE: Everything in the market is now encouraged to grow at 5% (or faster), just to keep up with "risk free government debt".

ELI5: What does this mean for the economy and markets?

tl;dr: stocks go down, investors less aggressive, tech job market stays dipped US Treasury Bonds are considered the risk-free rate. If you have $TICKER that you expect to yield 5%, you wouldn't buy it because you undertake risk to invest in a company to get 5%. You'd buy a Treasury bond instead to get 5% risk-free. As a consequence, stock prices should drop until yields + premium to take on risk exceeds the risk-free rate.

addaon 3y ago
> If you have $TICKER that you expect to yield 5%, you wouldn't buy it because you undertake risk to invest in a company to get 5%. If the expected value of the investment is 5%, that expectation incorporates the risk. There's a chance it yields -100%, there's a chance it yields 5%, there's a chance it yields 100%, etc. If your value of money is linear, you shouldn't have a preference between a(n individual) 5% investment with high variance and one with low variance. It's perfectly reasonable to prefer low variance for a given expected return, but it's also perfectly reasonable to prefer high variance; and of course a portfolio has an expected return and variance that's a non-trivial combination (due to correlated movement) of its individual investments.
MuffinFlavored 3y ago
> stays dipped stays dipped or this is the beginning of the dip and continues to dip further is a fear/the fear

nine_zeros 3y ago

Debt is continuing to become more and more expensive. Lenders are not lending to people or companies unless the interest rate is much higher than the risk-free 5% offered by the US government. VCs are not getting funds from LPs who all would much rather invest in US government treasuries for the easy 5%. Public stocks are often bought with margin money (which is leverage, aka debt). Now, margin money lenders are charging a higher interest rate on that margin, causing borrowers of margin money to not borrow as much. Thus, stocks are not being bid up as much, causing stock prices to drop. Mortgage rates track the 10-year Treasury yield and thus mortgage loan rates are going higher and higher. Housing market is expected to sag, if not go into a correction or a crash. For the average person, the only parts that are affected are: 1. If their employer is dependent on cheap money (real estate, VC tech, growth stocks) these employers will either need to innovate HARD or start laying off people under pressure from investors. 2. If you were looking to borrow money for some reason (say, a house or a car), you are looking at insane interest rates. But all of this happens in any interest rate rise. What is interesting about this particular threshold of 5% is that the world hasn't seen US treasury rates at this level since the last great recession. Most companies, stock holders, people in general don't know how to evaluate this new world of a higher rate. Should you buy that car you desperately need? Is relocation for an RTO job even possible? Higher interest rates, lower investment rates can have a devastating impact on people's lives.

dragontamer 3y ago

A 5% long-term "risk free" rate is roughly equivalent to a company who makes a 'PE Ratio of 20'. Or in other terms: a $1 Billion company should be making $0.05 Billion (or $50 Million/year) in profits to be comparable to a 10Y bond at 5%. Except... everyone accepts the fact that bonds from the US Treasury (the entity that can literally print US Dollars) is lower-risk than equity from a company. (Equity is junior: if companies go bankrupt they pay their debts first and equity secondly). So you "should" be making more money from equity than bonds/debt for it to make any amount of sense. Companies will have to change their PE ratios to compete in theory. The easiest way to do this is to... lose valuation. You can't just control profits so easily, so instead of being a $1 Billion company making $50 Million/year, it'd be easier to turn into a $0.5 Billion company making $50 Million/year (now a PE Ratio of 10, or clearly better than Bonds) Or so the theory of value-investing goes. Which... doesn't really work out in reality but hopefully you get the gist. ----------- Note that dividends are meaningless from this perspective. Profits are what matters. Companies take profits an invest into themselves, so it doesn't matter if the profits are emitted as dividends (ie: $50 Million returned to the shareholders in a dividend per year), or if the company buys a new $50 million factory each year. Either way, its "the shareholders property" and therefore equivalent. If the company buys a $50 million factory each year, then in theory, they've grown by $50 million bucks. Ex: the $1 Billion company is now a $1.05 Billion company, and are expected to make $52 Million next year. After all, the "bondholder" could have spent their 5% coupon on buying more bonds, so to be "equivalent" to the risk-free bond strategy, the company also has to grow exponentially. IE: Everything in the market is now encouraged to grow at 5% (or faster), just to keep up with "risk free government debt".