The Big Questions I’m Asking Myself These Days

Big Questions

The global financial markets are always eventful.  And yet, these days they seem even more eventful than average.

Here are some key questions I am noodling on these days.

Who Wins From The War?

To be very clear, I’ve got strong views on the war that’s going on.  The behavior of the Russian government and the general population seems to be going from really bad to much worse.

What makes me even more worried, however, is that there are far too many players out there who benefit from a prolonged conflict.

China is a clear beneficiary.  Nothing like watching two of your biggest competitors duke it out while you can take the moral high ground and play both sides.

Notwithstanding my full support for the US (in fact, I think they should be doing much more to support Ukraine), it also stands to benefit from the conflict – both economically (defense, oil & gas exports, etc.) and politically.

Now that they pulled the trigger, even Russia is a beneficiary.  With the economy in tatters, the only way for Putin and co to stay in power is by fomenting the “we are at war” mentality at home.

Finding yet another external enemy (US, NATO, a random gay parade) has proven to be a highly effective way to get Russians to go yet another year on buckwheat and potatoes.

The losers are clearly Ukraine (for obvious reasons) and Europe (refugees, economic disruption, war at its doorstep).

This is more than just a philosophical argument.  Ultimately, we are talking about a significant disparity between economic growth rates, career prospects, and investment returns.

If you have the requisite flexibility, you may want to tailor your career and investment strategy appropriately.

Are The Peace And Globalization Dividends Gone?

For thirty years now, we’ve benefitted from the (perception of) long-term peace and ever-increasing globalization.

Why build another nuclear submarine if you can provide free childcare to millions of people instead?

And why source commodities and basic components domestically if they are available at a fraction of the price from emerging economies?

The recent events have proven us wrong.  And while I am confident the world can sanction/wean itself off Russia’s oil and gas, I am concerned about what happens to global trade if China grows increasingly belligerent (see Taiwan).

We are already seeing an increased focus on in-sourcing, especially in strategic sectors like semiconductors.

Ultimately, bringing production back on domestic soil may have benefits like the revitalization of the middle class.  But it will also incur a significant economic cost.

Where Is Inflation Going To Shake Out?

US inflation was approaching 10% just a few weeks ago – and that was BEFORE the impact of the war, the sanctions, and the incremental supply-side shortages.

Now, historical inflation and forward inflation are two different things.  The aggressive rate signaling by the Fed is increasing the cost of borrowing now and should be putting some immediate damper on further price increases.

That being said, monetary policy is far from a precise weapon.

If the Fed undershoots, we could well end up with double-digit inflation at some point this year, which will quickly decimate mine and everyone else’s cash holdings.

By Asset Class

What Are The REAL Market Returns?

The past 15 years or so have been pretty easy as far as tracking your equity portfolio performance.

Inflation was either non-existent or negligible.  For people long US equities, you could pretty much take the annual S&P 500 return as a true measure of performance.

Not anymore.

If the S&P 500 is still at 4,500 this time next year, you aren’t flat – you are actually 10% (or whatever the inflation rate happens to be) down.

And if the S&P is at 4,950 – you aren’t up.  Nope – the market simply made you whole on your money.

For better or worse, we are living in a new reality, and many folks will require a paradigm shift to get used to it.

What Happens To My “Number”?

It is now abundantly clear that at least some of the stock market outperformance last year was driven by higher future inflation.

In other words, the stock market expected companies to raise their prices, which in turn would increase their earnings, even if just on a nominal basis.

Assuming a constant valuation multiple, stock prices (and indices) went up.

The FIRE community was happy to bank the gains.  Hardly a day went by without yet another “record net worth” update in my Twitter feed.

And yet, I am still to see anyone meaningfully increasing their target retirement “number”.

If you were aiming for $5m last year, you now need $5.5m.  And if you were going for $10m, you need a whole million more.

Sorry to rain on people’s parades, but it is a moving target – and it’s going in the wrong direction.

How High Will The Rates Go?

At the moment, I’m actually not that fussed about mortgage rates.

Sure, they’ve gone up dramatically in a very short period of time.

Still, we are not even at the levels seen back in October 2018, and I don’t recall any asset pricing tragedies back then.

Source: MortgageNewsDaily

On one hand, there are significant long-term deflationary forces at play.  Technology is one.  Globalization (if you believe it is here to stay) is another.

But if near-term inflation keeps galloping up and we cross the 5.5% – 6% barrier on the 15 year fixed rates, we could see some significant strain on the system.

After 10+ years of easy money, seeing rates go that high could place some significant stress on the mortgage borrowers (once the existing fixed-rate mortgages are up for renewal) as well as a host of other financial market participants.

What Happens To The Housing Market?

The “problem” with the housing market is that it’s unlike any other market out there.

Buying a house isn’t just a financial decision, it’s an emotional decision.  No one buys $500k of bonds because they want to settle down, raise kids, and build a treehouse in the backyard.

And so, you just can’t expect housing prices to react to interest rate rises the same way that other financial assets might.

People want (and need) a place to live.  Builders need to build houses (and they aren’t building enough right now).  Folks might stretch to buy houses by cutting back in other areas.

The baby boomer generation, sitting on massive levels of home equity, might look to unlock some of it to help their kids get a toehold in the market.

Now, I hope that the house prices decline, or at least moderate.  But due to the factors above, it’s not a given.

In theory, the commercial (i.e. multi-family / mixed-use) market should be more rational.  No one buys an investment property because their biological clock is ticking.

But it’s also not that simple.  If folks can’t buy a house, they need to rent.  If rents keep going up, so do the property values.

We will likely have clarity on some of the questions above within the next few months, while others may take years and decades to play out in a definitive way.

In the meantime, the most important thing you can do is to continue investing through the cycle.

No one gets all of the questions right.  But ultimately, we humans have been pretty damn good at prospering over time.

Stay disciplined, continue saving and investing, and you are bound to end up far ahead of where you have started.

As always, thank you for reading – and happy investing!

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Banker On FIRE is an M&A (mergers and acquisitions) investment banker. I am passionate about capital markets, behavioural economics, financial independence, and living the best life possible.

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9 thoughts on “The Big Questions I’m Asking Myself These Days”

  1. It really feels like it’s become a horrible time to be an investor. I have been following a passive, market cap weighted investment strategy for several years but now with the war in Ukraine and the response to Russias atrocities by emerging market countries, I don’t much feel like having my money in those countries anymore. Not everything has to be about making money because some things are worth a whole lot more.

    The problem then is, developed markets are dominated by the USA and there is a large concentration in a handful of “tech” companies. Which leads me to thinking about how to dilute US market weight, which in turn pushes me further and further from my once passive, ignore the noise plan.

    At least bond yields started rising a bit! I had started to consider DCA’ing back in as NAV’s fell but even that I’m totally unsure about.

    Cash is being eroded by higher inflation. What’s an investor to do!

    1. Banker On FIRE

      Yeah all good points. I wouldn’t want to have my capital supporting the Russian or Chinese enterprises. Not now, not in the future.

      Perhaps there will be a global ESG index of sort. You and I are not the only people to look at things from this viewpoint.

      As far as your statement about the S&P, I’m actually keen to see what the Big Tech proportion looks like post the recent sell off. My gut feel is that it declined meaningfully. Perhaps something to investigate for a future post!

      1. There are a few global ESG index, but as all other global indices they are very US-heavy. My one concern with having ~60% of my stock equity in US based assets is the inherent currency risk as a European. I believe the next couple of years will see the dollar weaken significantly. You might see avg stock prices rise, but with the underlaying currency devaluing and the inflation eating at your returns, it’s possible that the stock markets will have negative yields for the coming years. Only way to go is real estate! Gonna buy me a nice vacation home and some more rentals! Haha

        1. Properties won’t necessarily perform better than stocks (esp. in big cities when rental yields are already super low hence prone to suffer if rates go up) on an unlevered basis. Rents are unlikely to keep pace with inflation as real wage growth in negative. The great thing about properties is the option (albeit not really available in the UK) to lock a long term mortgage below current inflation rates (in another words the bank is paying you to borrow!). It’s very likely that all the performance in the next few years will come from the mortgage being eaten away by inflation and not from the asset overperformance (ie. owning property unlevered will lose you money).

          1. Banker On FIRE

            Don’t disagree with that at all

            Haven’t tracked European mortgage rates lately but have heard you could do a 10-year mortgage at <1% in Spain as recently as February

            At that rate, the real cost of the mortgage is somewhere between -5% and -10% !

  2. I am right there with you. I’m not entirely sure of what to make of new investment climate. And while I am trying to be optimistic that the US and Europe won’t get pulled into a new World War, it is certainly possible. I agree holding too much cash is problematic and as part of staving off sequence of returns, my plan is to hold a couple years worth of cash. But what happens if I deplete my cash and we are in a prolonged bear market? I’m not sure.

    Right now, I am just trying to focus on the fact that I don’t know what I don’t know, and this could go all sorts of directions. I truly just feel bad for the Ukrainian people. For now, holding on for the ride.

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