portfolio construction

[jk]

if you look back to the 1970's you see bonds and stocks selling off together. it is a mistake to think that a negative correlation between stocks and treasuries is a law of nature. it happens to be true of the last 40 years of disinflation, but it is not true over longer periods. and it will not be generally true in an inflationary era.

in the kind of giant selloff you posit i would expect falling prices for everything that isn't nailed down. you can cushion the blow by holding cash if you're willing to accept the drip, drip, drip of inflation eating away at its buying power. alternately you can keep a rolling position in puts, although - like all insurance- this can be expensive.

re uranium i think sprott taking over the uranium participation fund has acted as a catalyst for the recent run-up. the market price of uranium has for some time been below the cost of mining it. this is because there has been a huge overhang in the secondary market [decommissioned weapons with downgraded uranium?], so utilities have felt no need to make long term contracts for delivery. it was cheaper to just buy in the spot market. sprott is more aggressive than the people who were running the participation corporation- they have committed to pursuing a direct u.s. listing, and they have been aggressively buying uranium from the secondary market. as long as sruuf, a cef not an etf, is at a premium they issue at-the-market new stock and turn around and buy more metal. this drives up the price, and has in general maintained enough interest in sruuf to keep it at a premium most of the time.

i think this cycle, together with the need for more nuclear power for a realistic path to zero net carbon, plus the emergence of newly designed smaller, safer, modular reactors will all drive the cost of the metal to something above its cost of production.

as for safety, remember that the navy has been running small reactors in its submarines and aircraft carriers for many years.

re the fed's priorities, i have no doubt that they will throw the currency under the bus. whether that shows up relative to other currencies is unclear, since those will be debased as well, but we MUST produce inflation in a context of financial repression.

the best model, imo, is the 1940's, when govt debt was about 105% of gdp. there were huge spikes of inflation, up to 19%, interspersed with brief periods of mild deflation, -3%. by the early 1950's the debt had been reduced to something more manageable. federal tax revenues are already less than the total of interest payments and entitlement payments. the federal debt is quoted as roughly $29 trillion. this doesn't include the off-balance-sheet liabilities of social security, medicare and medicaid, and the present value of future interest payments. so we MUST debase the currency in order to meet those obligations on a nominal basis.

[Milton Kuo]

if you look back to the 1970's you see bonds and stocks selling off together. it is a mistake to think that a negative correlation between stocks and treasuries is a law of nature. it happens to be true of the last 40 years of disinflation, but it is not true over longer periods. and it will not be generally true in an inflationary era.

Yes, that's why I constrained my remark about U.S. Treasuries being the safe asset to reference the last 40 years. I also seem to remember that there were parts of the early 20th century where USTs also fell in sympathy with the stock market; correlation with the stock market was not something that only occurred in the 1970s. Correlation wouldn't bother me too much but when coupled with ridiculously low yields, I've made up my mind that I cannot tolerate that kind of asset in my portfolio contrary to what Portfolio Charts seems to suggest. At these high prices, not having bonds in a portfolio will increase the Ulcer Factor but, assuming one has steel nerves, returns should not be improved with bonds.

in the kind of giant selloff you posit i would expect falling prices for everything that isn't nailed down. you can cushion the blow by holding cash if you're willing to accept the drip, drip, drip of inflation eating away at its buying power. alternately you can keep a rolling position in puts, although - like all insurance- this can be expensive.

I've looked into puts and volatility products to hedge against a correction or crash but the cost is just too high. This is certainly a strange environment. People appear to be speculating without a care in the world yet short products are not in an anti-bubble. I guess Volmageddon and March 2020 have prevented an anti-bubble.

as for safety, remember that the navy has been running small reactors in its submarines and aircraft carriers for many years.

It is my belief that operation of nuclear power plants is relatively safe, especially in the armed forces where there is plenty of manpower and a practically unlimited budget to monitor and maintain the plants. The sailors have bona fide skin in the game because if they don't do a good job or outright don't do their jobs, they're going down with the ship, Heaven forbid if the ship is a submarine. What a terrible way to die. I have far less confidence in nuclear power plants run by people with very little skin in the game. I have even less confidence when private companies, likely headed by bean counters with no experience working in the trenches, will be managing nuclear power plants with a goal of "maximizing shareholder value" all in the context of weak, crippled, or corrupt regulators.

Nuclear waste processing and storage is even worse although catastrophes will not be as readily apparent.

re the fed's priorities, i have no doubt that they will throw the currency under the bus. whether that shows up relative to other currencies is unclear, since those will be debased as well, but we MUST produce inflation in a context of financial repression.

the best model, imo, is the 1940's, when govt debt was about 105% of gdp. there were huge spikes of inflation, up to 19%, interspersed with brief periods of mild deflation, -3%. by the early 1950's the debt had been reduced to something more manageable. federal tax revenues are already less than the total of interest payments and entitlement payments. the federal debt is quoted as roughly $29 trillion. this doesn't include the off-balance-sheet liabilities of social security, medicare and medicaid, and the present value of future interest payments. so we MUST debase the currency in order to meet those obligations on a nominal basis.

There is zero doubt in my mind that the dollar will lose purchasing power due to Federal Reserve actions. However, what I am uncertain about is what the Federal Reserve will do if the dollar starts losing purchasing power at a very, very high rate, say 15% - 20% per year. After all, if 10% inflation is good for reducing the debt burden, why not 90% or even 1,000% inflation to reduce it more quickly and thoroughly? There is some threshold at which the Federal Reserve may be forced to crash everything. Another difference between today and the past (1940s and 1950s as you state above, and the 1970s) is that *all* public institutions have lost their credibility with the public thanks to incompetence, corruption, and neverending lies that are easily detected. The rate of inflation is partly driven by public sentiment and public sentiment has an outsized influence on the rate of inflation when there is a surfeit of money in the system.

In light of how the public reacted after March 2020, I think the Federal Reserve is going to find out that the public will "shoot first, ask questions later" when it comes to inflation. If even the falsified inflation reports state inflation as 10%, I expect the velocity of money to really ramp up as people start dumping dollars for anything else. Is the Federal Reserve going to continue to have ZIRP, QE, etc. when that happens or is it going to crash the markets? From what I can tell, we appear to be in the early stages of a wage price increase positive feedback loop and we all know how much the Federal Reserve "likes" Americans' wages somewhat keeping up with inflation.

[jk]

you're right about velocity being key. but the fed will learn, if it doesn't know already, that they can't raise rates much without bankrupting the gov't. velocity rising would mean people are really convinced that inflation is very serious, and their dollars are hot potatoes- better to spend them before they lose more value. i think we have a way to go before that happens.

in the meantime, just as money market funds were forced by regulatory changes to put more money into treasuries, so too pension funds, insurance companies, banks, and even individual pension accounts could be mandated to hold some percentage of their assets in treasury paper. this could tie up a lot of money in negative yielding assets and help immobilize some dollars while capping yields.

[Milton Kuo]

in the meantime, just as money market funds were forced by regulatory changes to put more money into treasuries, so too pension funds, insurance companies, banks, and even individual pension accounts could be mandated to hold some percentage of their assets in treasury paper. this could tie up a lot of money in negative yielding assets and help immobilize some dollars while capping yields.

It's not clear to me how that is going to control inflation. It'll put a bid on U.S. Treasuries and maybe help cap yields but inflation is going to continue to be high--and perhaps continue going higher--if the Federal Reserve insists on more QE and other unconventional policies to prevent a stock market crash. Furthermore, it seems that each round of QE must be larger than the previous to prevent or arrest a market crash. I don't recall reading that idea anywhere but it certainly seems to be the case.

Everyone I've read who's offered an opinion about the situation believes as we do: The Federal Reserve will try to end QE and raise interest rates and the markets will eventually go into conniptions which will cause the Federal Reserve to resort to more QE and ZIRP. The question is how much of a market downturn and how precipitous must that downturn be before the Federal Reserve chickens out?

Part of me feels that the Federal Reserve may be playing a game of chicken. I've felt this way ever since QE3, where I thought that the instant retail and institutional investors went "all in," the Federal Reserve would immediately end the program since it managed to goad private money into overpriced assets ("Mission Accomplished"). This was the scenario that always made me think of Lucy van Pelt (the Federal Reserve) holding the football (asset price inflation) for Charlie Brown (retail investors). If I--likely acting with the herd--go all-in on the various casino games, the Federal Reserve will pull away the football.

March 2020 may have given the Federal Reserve confidence that it can reflate the bubble from a 30% correction. Might it try a 35% or 40% correction next time? The problem is that there is probably a tipping point at which the market truly panics and see a deep and sudden plunge, perhaps similar to what happened the day Lehman Brothers was allowed to go bust. If a market bust is never allowed to oocur due to massive liquidity injections and asset purchases, how could inflation ever temper, which is the whole point for ending QE and normalizing interest rates?

[jk]

i never said that mandating the purchase of treasury paper by insurance companies, pension plans and so on would reduce inflation. it would just be a way of capping yields by forcing various entities to hold negative real yield instruments.

i think we need inflation, probably for the rest of the decade, and we need financial repression but no one in an official capacity is allowed to say that. it's the only way to deal with the debt overhang and off-balance sheet liabilities without either hyperinflation or a total crash and depression.

the fed put still exists, the question is whether the strike price has moved down. i think it's not fixed- it would depend on the speed and extent of a market downturn, and especially it would depend on whether treasuries start getting sold along with stocks. i.e. equities going down and simultaneously yields rising is the fed's nightmare scenario.

the question that occurs to me is whether on the next go round, when stocks tank and at some point bonds are being sold as well, and then the fed intervenes, is what the market recovery looks like. i don't assume it will be the kind of rocket ship we got after march 2020.