Negative Mortgage Rates Arrive in Denmark. Yes. Negative Mortgage Rates.

I’m not about to translate an entire news article from Denmark, but here is the headline that hit the wire a little while ago:

Boliglån rammer negativ rente for første gang

Nordea Kredit skal nu føre penge tilbage til enkelte kunder i stedet for at opkræve dem, skriver JP Finans.

Translated courtesy of Google:

Mortgages frames negative rate for the first time

Nordea Kredit must now bring money back to individual customers instead of charging them , writes JP Financial .

Has deflation become so severe in the Eurozone that negative mortgage rates make sense?  Deflation, yes.  Paying people to take out mortgages, no.

If deflation has become such a severe problem that a banking system must pay people to borrow, the global economy is crawling on the razor’s edge.

These are strange times indeed.

Here is the link if you wish to translate the entire piece:

“I watched a snail crawl along the edge of a straight razor. That’s my dream; that’s my nightmare. Crawling, slithering, along the edge of a straight razor… and surviving. ” – Colonel Kurtz

– LL


American (or European) Py

This morning the European Central Bank made some very accommodative moves.  While the details are a little wonky, here is a rough summary (emphasis on “rough”):

  • Targeted Long-Term Refinancing Operations (TLRTO):  These operations are designed to “grease” the monetary policy transmission mechanism so accommodation becomes reflected in the “real” economy.  To make the operation more attractive to banks they may eliminate the premiums charged to banks and lower the benchmark rate.  Today’s announcement lowered the cost of funding to 0.10% above benchmark.
  • ECB to purchase ABS:  The idea here is for the banks to bundle various securitized loans and sell them to the ECB.  Today’s plan includes both new and existing Asset Based Securities and Residential Mortgage Backed Securities.
  • Lowered Rates:
    • Rates on main refinance operations were lowered to 0.05%
    • Rates on marginal lending were lowered to 0.30%
    • Rates on deposit facility were cut by 0.10% to -0.20%.  Yes.  Those little dashes in front of the percentages indicate that banks will be paying interest on the money they deposit at the ECB.

In the wake of this, rates on 2-year paper in eight European countries went negative; with the lowest negative rate being paid to Switzerland (-0.119%) and the highest negative going to Austria (-0.049%).  I think I’d balk at the privilege of paying the Swiss 0.119% to give them the use of my money.  But hey, that’s just me because apparently someone is willing or the rate wouldn’t be where it is!

As I write this, the EUR/USD has fallen 1.60% to 1.2939 – the ECB having (at least for now) the desired impact of hammering down the Euro.

In Europe, reactions in the equity markets were generally positive.  The DAX gained 1.02%, the FTSE gained 0.06%, and the CAC 40 gained 1.65%.

That’s a pretty healthy reaction.  It seems that draconian fixes are considered bullish while the underlying problems necessitating these fixes are ignored.  A money manager has to make his numbers each quarter, so I suppose that’s understandable on some level.

The US markets were generally positive early in the day, but the gains faded after the 159, 648th rumor came out of Ukraine.  This was the most recent of the 79, 824 bad news rumors, and it took the markets fractionally lower.

Early this week I linked an article about “liquidity traps.”  Roughly (again) defined, a liquidity trap is where injections of cash by a central bank into the private banking system fails to decrease interest rates because there is a prevailing belief that interest rates will soon rise.  Similarly, if the cash is not being deployed due to “hoarding” there is little impact on creating inflation (which a few countries could use right now…  Italy, I’m talking to you).  This is described as M * V = Py, where M is the money supply, V is the velocity of money, and Py is the product of price and units.  An increase in Py would be evidence of inflation.

Since there is no question that the Fed and the ECB are ramping up the “M”, and there is little evidence of an increase in “Py”, one could deduce that “V” is the lollygagger.  To wit, here is a quote from the St. Louis Fed’s website:

“During the first and second quarters of 2014, the velocity of the monetary base was at 4.4, its slowest pace on record. This means that every dollar in the monetary base was spent only 4.4 times in the economy during the past year, down from 17.2 just prior to the recession. This implies that the unprecedented monetary base increase driven by the Fed’s large money injections through its large-scale asset purchase programs has failed to cause at least a one-for-one proportional increase in nominal GDP. Thus, it is precisely the sharp decline in velocity that has offset the sharp increase in money supply, leading to the almost no change in nominal GDP.”  – Economist Yi Wen and Research Associate Maria Arias in a St. Louis Fed article:

Now, in full disclosure, the concept of the liquidity trap is a construct of Keynesian economics.  The Austrian School would argue that the lack of velocity during these periods of low interest rates is a result of previous mal-investment and the discounting of an assets value at an extremely low rate (time preference).

I wish I definitively knew the cause of the flaccid “V”, but after witnessing 5 years’ of ramping up “M”, I’m beginning to side with the Keynesians on this one.  It would seem that much mal-investment would have worked through the system at this point, resulting in some juicy Py.

Mmmmm.  Juicy Py.



The Grateful Dead and Noise Pollution

We started this business in 1992. Back then it was known as Bayfield Financial, then we took on some partners and changed the name to Irvin/Letterio Portfolio Management.   After that, we took on more partners and became Peregrine Advisers, subsequently sold the company to private equity, did a public offering, followed by a management buyback, ultimately becoming Altair Management Partners.

Over those years, we enjoyed the 1990’s tech bull market, endured the tech bubble popping, coasted along with the housing bull market, navigated the Great Recession, and marveled at the subsequent Fed-induced bull market.   We look back grateful that our flagship investment strategy never suffered a decline greater than single digits.

What a long, strange trip it’s been.

In a way, our longevity was helped along by doing our own research, having a distinctively contrarian viewpoint, and (most importantly) being able to glean causality from the events unfolding before us.

Which is what brings me to write this post.

For most of 2014, I’ve been witnessing things to which I cannot confidently attribute causation.   To wit, implied volatility (VIX) sits at 11.65; a full 19%+ below its level just one year ago.   At the same time, the S&P 500 melts upward to low volume all-time-highs.   All of this while the yield on the 10-year Treasury fall to 2.44% (a 15.6% decline in yields since the beginning of the year), and the yield curve continues to flatten.

So, bonds are rallying, stocks are rallying, volatility is practically non-existent, the yield curve is flattening and the Federal Reserve is backing out of bond purchases.   Strange bed-fellows.

I’ve picked my brain for the past few weeks trying to find a similar set of historical circumstances from which to glean some insight.   I’ve also been looking at foreign bond prices and currency pairs to assess the possible impact of the carry trade (which looks pretty possible).   I’ve dug through economic releases looking for inflation, stagflation, deflation, or disinflation (mixed bag, at best).   I’ve read bullish narratives (which sound like talking points), bearish narratives (which always sound too smart by half, which makes me dubious), and conspiracy narratives (for entertainment after reading all the dry material).

The takeaway for me is that I simply cannot explain the coincident movements in these indicators.   They seem counter-intuitive.   On a certain level they seem irrational.   They come across to me as so much noise.

When I say “noise, ” I mean a very specific kind of noise.   Let me give an example.   In instances where we employ third party managers, the dominant reason we terminate them tends to be noise.   It’s that unexplainable change in the way the manager is communicating, researching, staffing, or responding to inquiries.   It’s subtle, it’s often gradual, and it’s far more noticeable through intuition than through dogmatic questionnaires.   It’s one of those things you can’t quite put your finger on, but your intuition hears it.   It’s noise.

Over the past 22 years, we’ve had some luck factor into our achievements; but analysis would show that the single-most important factor was avoiding two major bear markets by our willingness to walk away when we heard the noise.    Simply put, if we can’t understand what we’re hearing we won’t invest in it.

Now, I wish I could provide some awesome technical and fundamental analysis for the reason we’re beginning to flatten out our exposures.   But as I said earlier, I can’t.   I can’t, because I can’t hear very well.   There is just too much noise. – LL


Buffet, Hussman, and Some Math

Much has been written of late regarding the stock market’s valuation after an amazing 5-year run.   More specifically, there have been several articles appearing recently addressing the concept of Market Cap to GDP as a valuation metric.   Such articles include “Market Cap to GDP:   The Buffett Valuation Indicator” by Doug Short and “The Federal Reserve’s Two-Legged Stool” by Dr. John Hussman.

Short’s article harkens back to a 2001 Fortune Magazine interview within which Warren Buffett called the Market Cap to GDP measure “probably the best single measure of where valuations stand at any given moment.”   Dr. Hussman, in his weekly commentary, went into great detail calculating expected forward market returns over a number of time frames based upon Market Cap to GDP.   They are both good reads, and I encourage anyone interested in the topic to look them up.

Warning:   At this point, this article is going to get wonky.   Not NASA wonky, but “more-algebra-than-is-remotely-interesting” wonky.   If you’re not one to wonk, feel free to skip to the conclusion.

In his article, Dr. Hussman ( explains that expected market returns can be broken into two components:   capital gains and dividends.   Capital gains are driven by two other factors:   “the growth in nominal GDP and the reversion in the ratio of market capitalization to GDP towards its historical norm.”

The first driver is somewhat direct:   GDP growth translates into capital growth.   The second driver, reversion to the mean, is the “wag” assumption in the calculation.   The “wag, ” however, is not without historical confirmation; despite the fact that timing the commencement of the reversion is next to impossible.

Now for the algebra, to estimate the annualized expected return E(r) of the stock market for the next 10 years, courtesy of Hussman (with the formulas presented differently by me):

Inputs:   Long Term Average GDP (LTAGDP)                          6.3%

Current S&P 500 Dividend Rate   (DIVRATE)                          1.86%

Historical Market Cap/GDP Ratio (HMCGDP)                        0.630

Current Market Cap/GDP Ratio (MCPGDP)                             1.251

Using these inputs, on can calculate the expected future returns of the market, assuming mean reversion of the market cap to GDP ratio as follows:


Plugging in the inputs, we get the growth component delivering E(r) of -0.75%.   Add to that the dividend rate of 1.86% and you arrive at an annualized E(r) for the market for the next 10 years of 1.11%.

Not very exciting.

To make a basic test of validity, Hussman ran the same equation from 2009.   The inputs from then were as follows:

Inputs:   Long Term Average GDP (LTAGDP)                          6.3%

Current S&P 500 Dividend Rate   (DIVRATE)                         3.60%

Historical Market Cap/GDP Ratio (HMCGDP)                        0.630

Current Market Cap/GDP Ratio (MCPGDP)                             0.600

Note that the MCPGDP was less than half of where it presently resides (1.251).

Plugging these numbers into the formula you arrive at an annualized E(r) for the market for the next 10 years of 10.42%.

That’s pretty darn good.

Here’s where I take the Hussman calculations one step further in order to see if the E(r) of 1.11% is reasonable in light of where we came from at the market’s nadir in 2009.

We determined above that, from 2009, the 10-year annualized E(r) was 10.42%.   We also know that the past 5-years’ annualized returns have been 20.19%.   If we believe that the 10.42% annualized return is close to being accurate, what does that portend for the next 5 years?   To calculate that, I began by valuing $100 invested in 2009 compounded by the known 20.19% annualized return.   That looks something like this:

$100(1+.2019)^5 = $250.81

I then calculated what we should expect that $100 investment to be after 10 years, using our E(r) of 10.42% as follows:

$100(1+.1042)^10 = $269.45

So…   We expect to have $269.45 after 10 years, but we’ve already risen to $250.81 in 5.   That leaves us to calculate what annual return we should expect over the next 5 years to reach are target.   That is calculated as follows:

(269.45/250.81)^0.2 – 1 = 1.44%

Once again, not very exciting


IF…   you, like Buffet, believe that Market Cap to GDP is the single best measure of market valuations, and

IF…   you, like Hussman, believe that the mean reversion formula can roughly project forward returns, and

IF…   you’ve stuck with this blog long enough to make it this far,

THEN…   we are in for an intermediate period of sub-par index performance.

Obviously this is only one metric to look at when attempting to determine market over/under valuations.   But, I like it.   It confirms what can be expressed more simply without all the math:

After 5 years of equity demand being pulled forward, reflected by a 20.2% 5-year annualized return, we might expect lower returns over the next 5 years as markets return to their normal long term averages.

– LL



Upon today’s release of the dovish Fed Minutes, the stock market lit up.   As this is being typed the S&P 500 gained 1%, the DJIA gained 1% and the NASDAQ leapt 1.6%.   The reason for the buzz:   ZIRP.   Our old friend the Zero Interest Rate Policy.

In the minutes, the Fed revealed that the market’s outlook regarding the timing of future interest rate hikes, “overstate the rate rise pace.”

That was all the market needed.   Jawbone a little ZIRP and stocks get high.

To wit, the 50 most shorted stocks in the S&P 500 were down an average of 2% at the end of March.   Some fell more than 20% — placing them squarely in bear market territory.   As of 3:45 pm, 17 of the 50 are outperforming the market, and 9 of them have eclipsed their average 2014 declines.

 A little Fed cough syrup really calmed down a market that had been hacking quite loudly recently.

Pass the Jolly Ranchers. – LL