Why Have Rising Yields Hurt Tech Stocks?

Since the end of Q3 2020, there has been a marked rotation from ‘pandemic stocks’ (mainly tech) to ‘recovery stocks’ (industrials, financials, consumer discretionary, etc.). Many tech stocks – like Amazon, Facebook Netflix, Zoom – are flat-to-down while the broader market hits new all time highs.

While there might be some intuitive sense to this as return to normal approaches, many people are pointing to rising yields as the cause.

Why Rising Yields Impacts Some Stocks More Than Others

Many people understand that rising yields have a negative impact on the prices of bonds. A bond represents a series of cash flows in the future. The higher the discount rate (of which the risk free rate is a part) the lower the present value of those cash flows.

The sensitivity of a bond’s price to changes in yield is neatly wrapped up in a single data point called ‘duration’. Higher duration bonds have a greater sensitivity to changes in yields.

Duration can be sort of described as a weighted average of time to receive cash flows. The longer it takes to receive cash flows, on average, the higher the duration.

Therefore, a zero coupon bond will have a higher duration than a coupon-paying bond. All things equal, a 30 year bond will have a higher duration than a 10 year bond. And so on.

While many people understand how duration impacts bond prices, they forget that the same concept applies to stocks.

You can look at a stock like an infinite-term bond. In doing so, it becomes clear that a non-dividend paying stock (like most tech stocks) have a higher duration than more traditional dividend-paying stocks.

Going even further, because many tech companies don’t generate positive EBITDA or cash flow they trade on the expectation of a potential cash flow in the future. In comparison, most recovery stocks are tried and true, generating reliable cash flows quarter-after-quarter. So when considering the cash flows generated by the firm itself, a business that might generate cash sometime in the future clearly has a higher duration than a business generating cash today. For these reasons, most tech stocks have a higher duration than most traditional stocks, and are therefore more sensitive to rising yields.

Bonus Point

Yields are a component of the cost of capital. A rising risk free rate raises the cost of capital for all businesses. While tech stocks operating on promises of future cash flows might do well when money is virtually free, they face rising challenges when capital becomes more scarce or expensive. In comparison, businesses that can fund capital investment via retained earnings and current assets (i.e. through realized earnings and cash on hand) and don’t have to tap into capital markets to stay afloat may start to outperform when yields start to rise.

With all that said, let’s be real. As a proportion of where they were last August, yields have risen a lot. But in absolute terms, yields are basically near the bottom of a 10 year range. The 10 year US Treasury yield is essentially where it was a week before the pandemic started.

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Charlie Munger, Vice Chairman of Berkshire Hathaway, speaks at the Daily Journal Annual Meeting

Some notable quotes from Charlie Munger at the recent Daily Journal Annual Meeting:


Visual Summary: John Hussman’s Case for a Market Crash

John Hussman of Hussman Funds is pretty bearish. Others are bullish. But I think it’s investing best practice to listen to both the optimists and pessimists. Only then can you approach the markets with a balanced perspective.

In his most recent market commentary, Hussman makes several points that shouldn’t be ignored. His most recent commentary is quite long, so I’ve provided a visual summary of his key points and charts below:

Valuations are at record highs for all stocks (not just an especially expensive segment of the market). The chart below shows price-to-revenues broken down by decile. Across the entire range of valuations, all segments are at record price-to-revenue ratios.

S&P 500 median price-revenue ratios by valuation decile

The same is true when breaking down the market by market capitalization. Small, medium and large cap stocks are all trading at record valuations.

S&P 500 median price-revenue ratio by market capitalization

Companies with negative earnings in particular have skyrocketed in valuation. This speaks to investor focus on the future. Unfortunately, expectations – like during the Internet bubble – often go unrealized, and lofty valuations eventually fall back to Earth.

Goldman Sachs non-profitable technology basket

As an investment strategy, hope is prevalent in the IPO market too. New issues – such as the recent Bumble IPO, which jumped 64% on the day of listing – shoot to the moon. Yet, many of these companies barely have any earnings (or even revenues in many cases) to speak of. Again, investors are flocking to IPOs in the hope of profiting off massive future potential.

Renaissance new issues index

Investors are so confident in the future they are willing to borrow to place their bets. Accordingly, margin debt as a proportion of GDP is at record levels! Borrowing to invest is a risky strategy. While one can profit handsomely investing other people’s money during a bull market, once asset prices turn it can lead to poverty. Moreover, the collective level of margin debt tends to exacerbate market declines as investors clamor to liquidate at the same time.

Margin debt to GDP

The US stock market capitalization is at record highs relative to US GDP. The value of companies relative to the value of what they produce has risen immensely.

Total equity market capitalization to GDP

Perhaps these charts don’t concern you because you’re a ‘long-term’ investor. Well, they should.

Valuations tend to be a pretty good predictor of future returns. The chart below maps Hussman’s estimated 12yr forward returns against actual forward 12yr returns – you can see the fairly tight relationship. Currently, Hussman’s model is forecasting a forward annualized 12yr return of -2.15%. Yes, negative. And yes, it is possible that long-term returns are negative because it has happened before. Moreover, historical periods of negative long-term returns tend not to be graceful and orderly. Rather markets violently oscillate between upward momentum and downward spirals.

Estimated 12-year total return for a passive 60/30/10 portfolio allocation (Hussman)

Is Hussman right this time? I don’t know. Nobody can predict the future. And the future doesn’t have to look like the past. So who’s to say that valuations don’t stretch even further? Or that revenues and earnings climb rapidly to close the valuation gap?

I don’t know. You don’t know.

But what I do know is that history shows the risks are real. Hussman is observing rhe signposts.

I’m not arguing there will be a crash tomorrow. Yet, the probability of one grows as valuations are stretched and investors gain confidence.

My suggestion to all investors is to keep your confidence in check. If you start to feel highly confident in your investing prowess you may be taking on too much risk. Great declines are often preceded by great hubris. Be aware of your own behavioural biases and remind yourself that investing in stocks could mean losing 50% of your money at any point in time. And no, you’re not good enough to get out at the right time.

If Hussman’s market return projections are right, individual investors will perform far worse. Most investors tend to plough more money into investments near market peaks and withdraw money near market bottoms, experiencing all the downside and missing out on upside.

Consequently, most investors could have real world experiences far worse than -2.15% annualized over the next dozen years.

Read John Hussman’s full commentary.

Investing Wealth

GameStop (GME): Investors Losing Millions

You live by the sword, you die by the sword.

Within the course of a week, GameStop (GME) stock has moved from about $90 to $468 and back down to $90. Just a couple days ago I heard stories about people becoming multi-millionaires overnight. One person turned $50k into $48 million.

Those who cashed out did well. But there are thousands of people left holding the bag. Many people were drawn in AFTER the short squeeze already drove the price through $200, $300, $400 per share. Now the price is $90. Where will it be tomorrow?

With GME hitting $90 today, the war stories are just emerging. People are losing huge amounts of money that they only gambled a few days ago.

While blood flows in the streets, GME bagholders are rationalizing holding the stock. I’m not here to say they’re right or wrong. I am just telling you that this is a very dangerous financial game people are playing.

For many this goes beyond money. They are squeezing GameStock shorts to flip the bird to Wall Street. So they continue to hold and continue to average down. Still, money isn’t infinite and at some point people simply can’t afford to trade their futures away for a cause.

On the other hand, maybe these people are right to hold on. Maybe they all get super-rich. I have no idea, and neither do they. I only hope most people didn’t bet more than they can afford to lose. Unfortunately, it doesn’t seem that way.

Here are some examples of the damage people are experiencing and sharing on Reddit’s ‘Wall Street Bets’:

This person is down $38k in total (down $151k from peak).

Down $1.1 million over the past week.

r/wallstreetbets - Down $1.1 Million over the week, and I Didn’t Hear No Bell 💎 👊 🦍

This person says they are down $400k (although the pic shows something different).

This one speaks for itself.

Dave Portney has lost $700k. (I assume he’s talking about Vlad Tenev, Robinhood CEO.)

r/wallstreetbets - Paper hand bitch lol

The person at one point owned $8+million in GameStock. Now he holds $1.3 million.

r/wallstreetbets - GME YOLO UPDATE: DOWN ANOTHER $7,000,000 STILL HOLDING! ✋💎🤚 We will not let them scare us. 🚀🚀🚀🚀

Investing Wealth

Saving (Not Investing) is the Key to Wealth Creation

99% of conversations between investors are about the next hot stock or something else related to investment returns. Over the long run, the market delivers roughly 10% annualized return. Beating this is next to impossible, yet it’s something that pre-occupies much of mankind’s energy.

Here’s the thing. For most people it barely matters. Indeed, most people would make a much larger dent building wealth by spending less, saving more and simply dumping their savings into an index fund to get that 10%.

Most people don’t save 10% of their pay, and instead focus their energy trying to find the next Tesla. If successful, the % returns might be satisfying, but when it comes to wealth creation it’s dollars that matter.

So is it better to save 1% of your salary and earn a 10% return or save 10% and earn a 1% return?

The chart below compares two extremes for two individuals who earn $40,000 with an expected annual pay increase of 4%.

Person 1 saves 1% of their paycheck but manages to earn the market rate of 10%.

Person 2 saves 10% of their paycheck but dumps their money into a deposit paying 1%.

Over a 30 year career, Person 2 builds a nest egg 167% larger than Person 1. Now imagine if that person could save 10% and earn 10%?

Savings is the bedrock of wealth creation. Everything else comes second.


Why Deflation is Good for Bond Investors

Deflation is good for lenders. Inflation is good for borrowers. Why? It all has to do with the future real value of money.

If a dollar in the future is worth more than a dollar today, it becomes increasingly expensive (in real terms) to service debt and increasingly beneficial to receive coupon payments. When dollars become more valuable, purchasing power rises. This means you can buy more stuff with the same amount of money. (In reality, most of the time future dollars are worth less than today’s dollars due to inflation.)

Here’s an example: if I’ve lent out $100,000 in exchange for $10,000 annual payment plus principal at maturity, I would prefer those future payments to have greater real value. While I will receive $10,000 in all situations, the value of that $10,000 is affected by prevailing price trends. A deflationary price environment erodes the prices of goods and services, thereby making future dollars more valuable, benefiting lenders.

The following chart illustrates this concept:

If deflation is good for lenders, why wouldn’t banks seek to create a deflationary environment by reducing money supply? While deflation might benefit a single lender, widespread deflation would actually hurt lenders due to greater loan defaults. A deflationary spiral lowers prices, causing companies to cut production and reduce wages. This reduces aggregate demand, further pushing down prices. Asset prices decline are liquidated to cover rising cost of real debt, with many organizations forced into bankruptcy as asset values fall below liabilities.

Beyond this, our entire credit based economy is predicated on growth, of which inflation is a component. A combination of real growth (productivity growth + population growth) and inflation is required to cover aggregate interest costs within an economy. Since real growth is hard to create, inflation is the grease that keeps the economic wheels turning.

Investing Master Class

Peter Lynch: 10 Most Dangerous Things People Say About Stocks

1) If it’s gone down this much already, it can’t get any lower.
2) No Debt
3) If it’s gone this high already, how can it possibly go higher.
4) Eventually they always come back
5) It’s $3, how much can I lose.
6) It’s always darkest before the dawn.
7) When I rebound to 10, I’ll sell.
8) I don’t have to worry, I own conservative stocks.
9) Look at all the money I lost, because I didn’t buy.
10) Stock has gone up I must be correct, it gone down I must be wrong.
11) Avoid long shots

Income Investing Investing Wealth

New Year. Same Story.

December 31, 2020. We were all thankful that the worst year ever was finally over. Yet, so far 2021 is less than two weeks in and the drama is escalating.

I won’t get into the politics, because it’s the politics that is tearing us apart. Instead, I’ll focus on what we all agree on: this is some bullshit!

People are going broke, businesses are closing, folks are sick and dying. The population is at each others’ throats. Oh, and the climate is in slow collapse.

If there ever was a year to take personal responsibility, it’s 2021. Nobody is going to come fix your job, your marriage, your savings account. It’s up to each of us to make this a better world.

It wasn’t always this way. During the mid-20th century, most people could follow a predestined path that led to decent wealth and security. One didn’t really need to think or be different. You just needed to pick a direction and go. The baby boomer benefited from a post-war economic tide that lifted all boats. You had to f&ck up pretty bad to not do well as a boomer.

I don’t have to tell you those days are long gone.

Kids today enter the system saddled with debt because they were forced to get two masters degrees for an entry-level clerk job. Same job 50 years ago went to a high school grad. And that grad would then get married at 21, buy a house at 22 and support a nuclear family through to retirement on a single income and fat DB pension.

No more.

But you already knew this. You’ve seen the wealth disparity charts. Unless you’re one of the lucky ones, you’ve probably personally felt the pressures. I certainly have.

My story in 4 words: it’s all on me.

I have people depending on me to keep it together. Pay the bills, keep food on the table.

I have a successful career. But I fully realize it could end at any moment. I’ve seen dozens of my colleagues over the past 20 years hit a brick wall and never recover. This isn’t something people in their 20s know. Careers have an expiry date, and most end before planned retirement. This isn’t something most people decades ago had to consider.

If there’s one thing I want you to do this year, it’s this: consider what happens if your career ends next year, in 5 years, in 10 years. And when I say ‘end’ I mean END! Like your prospects are reduced down to shuffling coffees at the local diner.

How will you pay the rent and buy food?

With any luck, you have years to prepare. If you are young, you probably have many years of career growth ahead of you. But know this: 50 year old unemployed executives have few prospects. So prepare.

The simple answer many provide is to start a side hustle. Let me level with you. DumbWealth is my side hustle and I don’t make a dime. I do this as a labor of love and it’s still time-consuming and exhausting. I can’t imagine truly putting in an extra 4-5 hours a day after work (and life) to build a secondary source of income. I should, but who has the time or energy. Work, life, kids, exercise, chores. If you’re truly going to start a side hustle, one (or all) of these things inevitably gets neglected. You need a very understanding family and nearly infinite amounts of energy to build a viable side hustle.

OK, so why not take a hobby and try to make something of that?

Photography, painting, woodwork. Sounds great in theory, but turning a hobby into a business is a great way to kill that hobby. The business of photography is about 20% photography and 80% sales and marketing.

If you’re reading all this and saying “well, but…” then all the power to you. You might just be determined enough to pull it off. Some people are.

The rest of us need to build financial freedom in other ways. We need to save, invest and earn a little more at work. It’s a simple and powerful formula that most people neglect, either because it’s boring or they’re addicted to consumerism.

Cut your expenses, save as much as possible and invest that money in a portfolio that will eventually pay you for doing nothing. The income generated from an investment portfolio is probably the greatest gift we can give ourselves. It’s the one way to create a passive income without really doing much more than you’re already doing. You still work the same hours and have the same salary. You just need to sprinkle some planning and discipline onto your daily habits.

Start small, but start today. It’s a slow build that often leaves you questioning the plan. But keep at it and there should be a day when that investment portfolio earns enough to cover your basic needs if you were laid off. If all goes right, there might even be a day when that portfolio allows you to quit your job. That’s financial freedom.


5 Charts: 2020 Investment Performance and 2021 Investment Predictions

Silver was top performing commodity in 2020:

graphic of periodic table of commodity returns from 2011-2020

2021 predictions from 200+ reports summarized into one chart:

2021 predictions consensus

Top performing asset classes in 2020: US Large Cap wins again

Best and worst performing equity sectors in 2020

The Best and Worst Performing Sectors of 2020

2020 asset class performance, including maximum drawdown and performance since market bottom:

Major Asset Class Returns in 2020
ETFs and Funds

5 Actions to Take Before Even Considering Investing

For many, investing sounds like a way to get rich fast. People see insane returns of FAANG stocks and bitcoin and think that’s the ticket to wealth.

For some, it is.

For those who have truly built wealth, there are many things that come before investing.

First of all, most people shouldn’t expect to earn triple-digit – or even double-digit – returns into perpetuity. Depending on how far you go back, the average return for the S&P 500 is roughly 10%. Bond returns, even less. So a well diversified investor holding a balanced portfolio might reasonably expect a 6-8% return over the long run.

For someone with $10,000 to invest, that equates to a $600-800 annual return. Hell, even if that person could accomplish 100% returns he’d only gain $10,000 in year one. Nice, but not enough to become rich unless by some miracle that feat can be repeated numerous times.

Nobody gets rich giving all their money away.

Investing is something you do with accumulated wealth. It’s a way to get your money working for you and to maintain your purchasing power. But before you can do that you must first build wealth through simple, deliberate actions.

Action 1: Spend Less Than You Earn

Seems simple. But many don’t live by this rule and rely on their credit cards to cover regular expenses.

Nobody gets rich giving all their money away. It’s so simple I feel stupid for saying it, but here we are. To accumulate wealth you first need to spend less than you earn.

Action 2: Pay Off Credit Card Debt

If you have a credit card balance you’re likely paying around 20% interest. You’ll never beat that return in the market with any consistency. So do yourself a favor and pay off that credit card debt before investing.

Action 3: Aggressively Save

Simply spending more than you earn isn’t enough. Think about it this way: every dollar you save is a dollar less you have to earn in the future. The more you can save now, the closer you will get to financial independence.

While saving 10% of your paycheck might seem daunting, it’s a standard rule of thumb. However, I suggest saving as aggressively as possible. 10% should be the bare minimum.

Action 4: Don’t Leave Free Money On The Table

Many employers have share purchase or retirement savings matching plans. I’ve known so many people who have lost this free money out of sheer laziness. People walk away from a 20, 30, 50% match – equivalent to a 20, 30, 50% instant return – yet spend their energy trying to invest in the next Tesla.

Moreover, these employee savings plans, once set up, are usually a decision-free way to build wealth since the contributions are taken off your paycheck before you even realize the money even existed.

Action 5: Earn More Money

The average age of Robinhood user is 31, and the average account size is $1000-5000. Such small account sizes suggest these people don’t have alot of wealth.

These young people are wasting their time chasing stocks when they’d get a much higher ROI investing in themselves. At age 31, most people are near the bottom of the corporate ladder. Instead of putting $1000 into Air BnB stock, spend that money on a Python course, Canadian Securities Course or CFA designation.

A little self-improvement at such a young age will pay off multiple times over a lifetime.