02-10-2002 21:17									#361
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"If you don't expect a bull for the moment, I'd be wise to put your money into something that at least guarantees you a positive return for the next year or two, wouldn't you think so?"

I have no idea whether there will be a bull market any time soon, so no, I don't think wisdom has anything to do with it--or at least wisdom would only dictate the fact that you can't time a market. I'm just doing a simple comparison in returns over a long-term time horizon.

"And besides, you're forgetting that inflation doesn't only affect treasury returns, but also profit growth, so that 7-8% might be a couple of % lower."

I don't follow you. All of my numbers are nominal.

	02-10-2002 22:10									#362
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quote: Originally posted by DanS I have no idea whether there will be a bull market any time soon, so no, I don't think wisdom has anything to do with it--or at least wisdom would only dictate the fact that you can't time a market. I'm just doing a simple comparison in returns over a long-term time horizon.

I reacted on this sentence of yours: "No, no basis for a bull. But considering what is available otherwise...", which seems to imply to me that you don't see any alternatives at short term.

But if you were thinking about the LT from the start, timing does matter if the market still has 1/3 to go on the downside.
And remember that 7-8% is just an average that consisted of a huge bull market that made up for decades of stagnation or loss.

quote: I don't follow you. All of my numbers are nominal.

You were comparing current 10-year treasuries rates with the historical average of stock return but you're forgetting that the treasury rate is this low because they're expecting very low inflation the next decade (about 1.5%) while the stock return average was formed in decades of inflation much higher than that. Hence my idea that stock returns will be much lower as well if the inflation forecast is correct, because the inflation rate impacts earnings growth. (obviously)

So, if you're using the 7-8% average, you're assuming that inflation will be higher than they forecast, which makes me wonder why you wouldn't buy inflation protected treasuries.

	03-10-2002 04:05									#363
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quote: Originally posted by Colon ... put your money into something that at least guarantees you a positive return for the next year or two, wouldn't you think so? And if you expect inflation to pick up, why not purchase inflation protected treasuries?

Ah, inflation indexed treasuries and something with a positive return...

by the by, in the States the inflation indexed treasuries have a very long payout tail and therefore duration, so they tend to move coincident with other treasuries, not inverse. If the yield curve backs up because of rising inflation, inflation indexed bonds will get crushed. Seems ass backward odd, but that is the way they work.

What does guarantee a positive real return over the next year? Nothing I know of!


Roland - (all was well and dry in Mozartland until they left)

I owe you two responses, I see.

Why would the Treasury rally reverse when mortgage refinancing slows? The traded mortgage market in the states is huge. Fixed rate mortgages outstanding at monthend were over $2.7 trillion. Comparably traded US Treasuries totaled less than $1.7 trillion, US Agency debt was $960 billion, and investment grade corporates were just over $2 trillion. At monthend February, the duration of the outstanding mortgages was 2.90, at monthend September it was 0.91.

As mortgages shorten their duration from expected prepayments, portfolio managers at Banks, Agencies, and Investment houses have to buy longer durated assets to offset the duration reduction until the new long duration mortgages come to market. So you get purchases of long treasury notes and bonds. This process is generally a sixty to ninety day type of window. So as new mortgages are packaged and issued, Banks, Agencies, and Investment houses roll over their prepayments into the new longer duration loans and sell long treasuries to keep from having their durations extend too far.

This process doesn't have much to do with the Fed, or the mortgage agencies for that matter. It is just a function of the mathmatics of a securtized mortgage instrument that can be refinanced at a low fixed cost at the borrowers discretion.


The US mortgage industry is something of a capitalism phenomenon. For years, people did their banking with small local lending institutions. At that time, almost all residential mortgage loans were for 30yrs at a fixed rate of interest; the banks hated it when a client wanted to refinance, and charged large fees to dissuade clients from pursuing that option. When banking laws were liberalized here in the states to allow for larger geographical distribution systems, a lot of banks found out that they had very geographically concentrated loan portfolios. The first pooled mortgage securities were issued at a time when the manufacturing sensitive regions were having an awful time, so the banks there quickly realized that they could diversify their loan exposure by securitizing their mortgages.

Eventually most banks realized that selling off local loans and buying back a generic diversified substitute was a great risk management tool. Since those banks no longer owned the specific loan they had made on Mr & Mrs Smith's house, they stopped making it difficult for the Smiths to refinance. Then they started trying to get the Jones' who banked across the street to refinance with them. The way they did that was by offering a variety of loan structures like 15 year fixed rate loans, 5 year balloon payment loans, adjustable rate loans, etc.

Now the average homebuyer can finance the purchase of a house or refinance their existing loan with hundreds of competing firms offering tens of different structures. Since the primary structural change in loans has been a move down to the shorter end of the yield curve, the average home loan would carry a lower rate of interest today than it used to, even if rates had stayed exactly the same. This lower "discount rate," if you will, has provided a natural tailwind to housing valuations that will only cease when financing innovations cease, or become counter productive.

One could argue that a certain percentage of financing options available today are counter productive, though if they are not pervaisively used, their effects may be marginalized. In any case, the average loan today is not yet a 125% of market value Interest Only Adjustable Rate Floater at a 4% teaser for a year and then reset to Tbills +675bp with a quarterly reset, uncapped and a 5 year final.



Was that post long enough???

	03-10-2002 12:51									#364
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Longposting bastard.

"This process doesn't have much to do with the Fed, or the mortgage agencies for that matter. It is just a function of the mathmatics of a securtized mortgage instrument that can be refinanced at a low fixed cost at the borrowers discretion."

I thought you were talking about some fundamental turnaround. If I understand correctly you say there will be a shortterm correction ?

Btw, I don't think we've seen the last refinancing round in this game....

	03-10-2002 13:01									#365
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"At that time, almost all residential mortgage loans were for 30yrs at a fixed rate of interest"

Aha... odd.

"Since the primary structural change in loans has been a move down to the shorter end of the yield curve, the average home loan would carry a lower rate of interest today than it used to, even if rates had stayed exactly the same."

Well there's a reason why the yield curve usually is not inverted. Where did that reason go in the securitization game ?

"In any case, the average loan today is not yet a 125% of market value Interest Only Adjustable Rate Floater at a 4% teaser for a year and then reset to Tbills +675bp with a quarterly reset, uncapped and a 5 year final."

Sounds funny. Anyway, as you seem to think innovative products are important, I can describe my mortgage deal:

120k € loan. At first 185 k loan at 3.5 %, 65k of which is put on a tax-favoured building-saving account at 1.5 % interest, for 3 years (bridge financing).

Then the actual loan is given fixed at 4.25 % for 10 years, effective ~4.5 % due to a couple of fees.

For the remaining duration of 15 years the rate will be fixed at the beginning at the average 3 month euribor of the last 12 months, rounded on 25 bp, + 150 bp. But capped between 4-6 % in any case. As the nominal rate should hover around 4 %, the bastards have calculated that they'll usually get towards the 6 % top.

Prepayment is possible up to 36 (or 72 ? not sure now) monthly rates, above that you need the consent of the lender.

I've been digging through half a dozen offers with different structures. So why is our real estate market not booming ?

	03-10-2002 18:31									#366
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--"Anyway, as you seem to think innovative products are important, I can describe my mortgage deal:

120k € loan. At first 185 k loan at 3.5 %, 65k of which is put on a tax-favoured building-saving account at 1.5 % interest, for 3 years (bridge financing).

Then the actual loan is given fixed at 4.25 % for 10 years, effective ~4.5 % due to a couple of fees.

For the remaining duration of 15 years the rate will be fixed at the beginning at the average 3 month euribor of the last 12 months, rounded on 25 bp, + 150 bp. But capped between 4-6 % in any case. As the nominal rate should hover around 4 %, the bastards have calculated that they'll usually get towards the 6 % top. "

BAUSPARKASSE IS EVIL !

Our parliament is trying to push through something like that. Bah!

	03-10-2002 18:34									#367
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"BAUSPARKASSE IS EVIL !"



Faaaar better than the Yankee GSEs and excessive tax subsidies.

	03-10-2002 20:31									#368
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--"Faaaar better than the Yankee GSEs and excessive tax subsidies."

Seriously, though, there should be no tax advantages. Like here, now.

	03-10-2002 20:36									#369
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Absolutely. But the tax advantage of the whole thing is quite limited. Unfortunately.

I missed the real pork fest, and that's the so called "Wohnbauförderung". I'm above the income threshold.

	03-10-2002 20:51									#370
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Geez, those german Uberwords

	04-10-2002 00:12									#371
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Could someone tell me (for educational purposes) what the such called "surrender value" British life insurers apply is?

	04-10-2002 01:12									#372
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If it is anything like the American version, some life insurance policies can be cancelled and the original purchasor can get their premiums repaid at some sort of anemic accrued interest.

Insurerers must include in their financial reporting a figure representing the impact that cancellations and payouts would have on their financial condition. Payouts would reduce future liabilities for death benefits, at the cost of reducing invested assets liquidated to make the payout.

That should be close.



Euribor still sounds weird to me. Can you guys get it changed to something else??

Hej Roland, I like your loan structure! It would fit right in over here.


More US Mortgage securitization info that you really didn't want to know. The GSE only repackage Conforming loans. The maximum loan size is 2x the 80% of the median home price. That makes the maximum GSE wrapped loan a paltry $250,000 or so. Now anywhere else in the country that is a nice house, but here in my back yard, that won't buy me a three-person NorthFace tent. Sucks to be me.

The 'other' factor, and, in my mind the important factor pushing up home prices in the States United, is a change in the tax code to make capital gains from both primary and secondary residences tax exempt up to 500,000 for a married couple, every two years. It is an amazing tax break, that really only benefits the Californial market and some eastern metros, but it does encourage people to buy the biggest house they can and hope the price goes up.

	07-10-2002 12:17									#373
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"The GSE only repackage Conforming loans. The maximum loan size is 2x the 80% of the median home price. That makes the maximum GSE wrapped loan a paltry $250,000 or so."

Well 160 % of the median is still a lot of wood. Does that rule apply to the Federal home loan something, too ?

"It is an amazing tax break, that really only benefits the Californial market and some eastern metros, but it does encourage people to buy the biggest house they can and hope the price goes up."

Well that may create some extra froth in those areas. But overall ultra cheap money, tax subsidies, government guarantee subsidies, structured finance and inflationary expectations make a nice bubble.

	08-10-2002 23:38									#374
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quote: Originally posted by Sten Sture If it is anything like the American version, some life insurance policies can be cancelled and the original purchasor can get their premiums repaid at some sort of anemic accrued interest. Insurerers must include in their financial reporting a figure representing the impact that cancellations and payouts would have on their financial condition. Payouts would reduce future liabilities for death benefits, at the cost of reducing invested assets liquidated to make the payout. That should be close.

Yep that's probably it. I was reading a little about the surrender value policies at British life-insurers in the early 90's, which was quite unfair, at the least. (but maybe you know all about that already)

	16-10-2002 23:48									#375
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"And remember that 7-8% is just an average that consisted of a huge bull market that made up for decades of stagnation or loss."

I think I'm now following you. Put simply, my 7-8% is not based on past performance. Just a coincidence that they might match. Rather, the nominal long-term GDP growth rate is assumed to be 6% (3.5% real growth + 2.5% unreal).

Then you plug in Buffett's assumption that earnings as a percentage of GDP is set by the US economic system to be within a certain range. Of course, this is a big assumption, but not an unreasonable one.

Then follows an observation that current and next year earnings reflect some %-age shy of the long-term expected earnings as a % of GDP.

Then take a look at forward S&P P/E, which shows a 5-6% return at current price. Adjust this return upward over the long term to take into account a reversion to earnings as % of GDP.

As a rule-of-thumb, this seems to show that 825 on the S&P is no longer irrational exuberance in comparison to what can be had from the gov't.

Last edited by DanS on 16-10-2002 at 23:53

	17-10-2002 02:21									#376
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Just noticed today that there are some pretty smart people (Bill Miller at Legg Mason, plus Clipper Funds) scooping up Tyco (TYC) stock, plus a lot of people willing to sell it. Anybody know what is going on here?

	17-10-2002 12:50									#377
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"Rather, the nominal long-term GDP growth rate is assumed to be 6% (3.5% real growth + 2.5% unreal)."

The 2.5 % being the BEA's fudge factor ?

Anyway GDP growth has nothing to do with stock price appreciation, unless you'd get it from a stagnant capital stock.

"Then take a look at forward S&P P/E, which shows a 5-6% return at current price."

Where are we now ? And which earnings are we supposed to use for that ?

Anyway stocks should yield something a good deal over the average return on capital for their volatility, and 7 % is a reasonable estimate there which also happens to be a long term average.

	17-10-2002 12:53									#378
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Haven't followed Tyco. Maybe they are speculating or have insider info that someone will take over some junks. GE was interested in Tyco's lending business, was it not ?

Which deverses a big fat

	17-10-2002 13:51									#379
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[QUOTE] Originally posted by Roland

Anyway GDP growth has nothing to do with stock price appreciation.

Don't see your thinking here. The price of a stock is predominantly the sum of discounted flows that ownership of the stock entitles you to, which of course depend on profits. The 2 modifiers that are critical are the rating investors ascertain to those profits (usually picked up by the p/e ratio) and the equity risk premium. This exists because of volatility, but more importantly because equity is settled after debt if the sh1t hits the fan.

Personally I expect 6%-7% nominal over the next few years (the hard part is not the profit outlook but the behaviour of the slippery equity risk premium ).........the long term investor should be ok.

	17-10-2002 14:16									#380
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"The price of a stock is predominantly the sum of discounted flows that ownership of the stock entitles you to, which of course depend on profits."

Sure. Just that GDP growth is roughly in line with the growth of the Capital stock. So if a company can grow my return without deluding my share, excellent. Just in the aggregate I'm very skeptical of any significant movement in that direction.

	17-10-2002 14:44									#381
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Still a little perplexed as to why you think real gdp growth doesn't have a widespread effect on company profits. That just isn't true. Otherwise why would stock markets rise in real terms at all?

	17-10-2002 14:50									#382
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GDP growth (long term, forgetting short term effects like pricing power etc) has an effect on aggregate corporate profits. It just does not help the profit per unit of employed capital, assuming the capital stock expands in line with GDP.

"Otherwise why would stock markets rise in real terms at all?"

Ehm... why would my point exclude stocks rising in real terms ?

	17-10-2002 22:39									#383
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"It just does not help the profit per unit of employed capital, assuming the capital stock expands in line with GDP."

Isn't this just a fancy-schmancy way of saying that companies retain earnings?

"Where are we now ?"

31x past earnings. Assume 20x or so forward earnings.

Last edited by DanS on 17-10-2002 at 22:47

	17-10-2002 23:30									#384
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EDIT: DP - my first ever!

Last edited by DrSpike on 17-10-2002 at 23:37

	17-10-2002 23:34									#385
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quote: Originally posted by Roland GDP growth has an effect on aggregate corporate profits. It just does not help the profit per unit of employed capital, assuming the capital stock expands in line with GDP.

Whilst it is admirable that you attempt a steady state analysis this is unfortunately misleading here. At present demand growth in the US is insufficient to close to the output gap, so as GDP growth returns towards trend growth both aggregate profits and the profit per unit of employed capital will undoubtedly rise. Also, the earnings rise is usually augmented by re-rating (p/e rises) as expectations change.

In the steady state the statement isn't quite true either......but that's not that relevant to the debate. Check out the Solow model if you're interested (yes this is the same Solow whose interview I linked to above).

	18-10-2002 01:41									#386
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quote: Originally posted by DrSpike ... more importantly because equity is settled after debt if the sh1t hits the fan.

That's right lads, get in line back there -->


On the GSE wrap coverage: GNMA is the lower income lower loan size wrap. Their loans are maxed at ~125m or so, but the average loan is much less... 50-65 iirc.

Again, the GSEs are secondary marketing vehicles. They repackage and wrap conforming loans from the banks that make the loans. Effectively they just commoditize an existing, but previously illiquid product. This "subsidy" is probably the most cost effective thing the US govt has ever done, with the best social results. Encouraging home ownership is a hands down public policy winner.

If residential housing is super affordable for nearly everyone in the States, I don't see how that can be construed as a bubble. There certainly isn't the supply and demand imbalance that have accompanied other bubbles in history.


By the by, I will state again that we have not had a widespread bubble economy, we have had a capital markets bubble in a relatively small sector. The GDP numbers prove this out. The internet never amounted to much of the real economy. Retail sales over the internet were less that 0.5% of all retail sales in 2000 iirc. In 97-2000 there was difficulty in the manufacturing economy. If Greenspan would have tightened FedFunds to try to crimp the tech stock bubble it would have likely had the reverse effect by further damaging beat-up sectors of the actual economy, and depressing those stocks - making pie-in-the-sky hyper growth dreams seem even better in comparison. The tech bubble was not a result of Fed policy, it was the natural outgrowth of modern portfolio theory favoring growth stocks in the wake of the capital gains tax cut. And I for one don't want the Fed to make system wide policy changes to a Poke-mon trading card bubble in the marketplace at the expense of the real economy.

Don't blame the Fed.

(I sold a truck full of Tbonds last week do-dah do-dah )

	18-10-2002 01:46									#387
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Finance guy talks sense. Sense is good

	18-10-2002 12:27									#388
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"Isn't this just a fancy-schmancy way of saying that companies retain earnings?"

Almost, yes.

"At present demand growth in the US is insufficient to close to the output gap, so as GDP growth returns towards trend growth both aggregate profits and the profit per unit of employed capital will undoubtedly rise."

Which is why I said above "GDP growth (long term, forgetting short term effects like pricing power etc)". Or should I say trend growth rates, ignoring cyclical effects.

"In the steady state the statement isn't quite true either......"

First I'm not talking about a steady state (assuming you mean one where net investment is zero).

Second what would the Solow model tell us about it ? Are you talking about the technology component, or what ?

	18-10-2002 12:38									#389
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Sten:

"By the by, I will state again that we have not had a widespread bubble economy, we have had a capital markets bubble in a relatively small sector."

With a household savings rate that dipped to around zero, a current account deficit that's approaching 5 % of GDP, and record debt levels ?

Nope.

	18-10-2002 19:31									#390
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quote: Originally posted by Roland Which is why I said above "GDP growth (long term, forgetting short term effects like pricing power etc)". Or should I say trend growth rates, ignoring cyclical effects.

Man you are slippery. There is a whale of a difference between what you indicated first time and what you just added, as I'm almost certain you know. You must command a high price as a laywer.

The statement you made that I originally quoted only makes sense at all in a steady state (though not quite as strict an interpretation as zero net investment) - if you weren't aiming for that it makes no sense. So you now agree there will be a cyclical effect, and since the original debate was about whether a pick up in growth would affect stock market valuations you agree with what I said.

Hence gdp growth - profit growth (and probable rerating) - stock price growth, which contradicts the quote from your post I originally made that I objected to.