It’s been 60 days and we’re starting to see the beginning of the adjustment from higher rates. Average 30-year mortgage chart below.
Inventory is back at pre-COVID levels and prices are moving sideways. My feeling is the market is going to get cheaper.
This is a yield-based feeling.
Let’s look at the current yield curve.
A simple metric I use for vacation markets.
What is “one week rental” relative to capital value?
I priced two markets this past week. These are not Christmas or Holiday Weekend rates, but they are December to February high season weeks.
Jackson – $10,000 a week relative to $4-6 million capital value
Vail – $5,000 a week relative to $2-4 million capital value
This is where the Yield Curve is useful – the 6 mth (to 30-year) rate is ~3%
3% of $5 million is $150,000 per annum vs $10K a week to rent
For nearly all users, the secondary market has swung strongly in favor of rent vs buy.
Other impacts… the stock market ~19% off its peak, crypto down, commodities down, China property market under stress, hot war in Europe, US Fed in a tightening cycle…
These changes, combined, are making marginal buyers less wealthy.
All prices move at the margin.
What does this mean?
My #1 investment principle is to construct a life where I don’t need to be right.
If the Central Banks are done bailing out financial assets then it makes sense for the price of financial assets to fall. The free-money era pulled returns forward and some of that will need to go back into the future.
That said, the recent past shows a clear bias towards continuous financial bail outs.
Impossible to know what will happen.
A note on inflation, as I see it.
If you own financial assets then you’ve been “paid” in asset appreciation over the last few years – SP500 is up ~50% over last 5 years.
Going back further, say 2010, the owners of financial assets have grown accustomed to unearned wealth.
So the best hedge against the market (& inflation) was letting personal spending decline, as a percentage of family assets, across the run up.
If you didn’t own assets then, hopefully, you’re in a skilled profession where you’ve been able to increase your income faster than inflation. If not then your best investment is up-skilling yourself.
The recent past, and media, are skewing your perception of inflation.
What’s your best guess for the 10-year breakeven inflation rate?
It peaked at 3% in the spring, currently 2.4%
1.03 ^ 10 = 1.34, 34% price increase over last 10 years
If, like me, you were building a family then your core cost of living is up WAY more than 34%.
When I look at our family budget, I can see a big part of our increase is lifestyle inflation.
For many of us: the long bull market has driven lifestyle inflation well ahead of the price inflation we’ve experienced.
Again, the best hedge is either: (a) not ramping spending, or (b) staying variable so the family can cut spending quickly, if required.
For perspective compare 34% 10-year inflation to…
SP500 10-year total return => 175% increase
The 10-year price of wherever you happen to be living
Short-term price inflation is nothing compared to long-term asset value inflation.
Given the future is unknowable (bailouts, ZIRP and money creation):
The picture is what it cost to send a first class letter when I married my lovely wife. The 55c cost today (+34%) is a reminder that inflation ticks away one penny at a time.
When it comes to inflation/deflation, I like to maintain a neutral position. More broadly, I seek to avoid the need to pick winners.
I also avoid making predictions about an unknowable future. Most importantly, because it’s impossible (!) but also because I have no idea what my life is going to be like ten years from now.
What follows is present-focused.
Quantify Your Exposure
Start with your core cost of living – that’s what’s going to inflate and outliving your money is a key risk.
What’s in my Core Cost of Living?
Healthcare ($19,300 of premiums and $7,200 to a family HSA for a plan with a $14K family deductible) – this sector is ripe for disruption, I get little for my spending
Taxes, Utilities, Car Costs and Insurance
Food, Clothing and Kid Activities
Childcare – a massive line item 2009 to 2019, now a source of income for the family, our middle-schooler is a sitter
Mortgage, rent, car loans – my main project from 2010 to 2020 was getting this down to zero – once that was achieved, I went a step further and turned it into a source of income
Next, consider your sources of passive and active income. Rents, royalties, dividends, interest (at least in the good old days), consulting and any other forms of income. Write it all out.
Compare your Cost of Living with the Sources of Income and calculate your net burn rate, or your net annual surplus.
Net annual surplus gets routed to discretionary spending, luxury items and/or new investment capital.
The best investment decision I ever made had nothing to do with asset allocation. From 1990 to 2008, I routed 50% of my gross income to new investment capital.
In my early 20s – healthcare costs were peanuts, no childcare costs, living in a shared apartment… I saved a ton. Good thing, too. I had no idea how much my cost of living would pop when I had kids.
My 40s (2009 to 2018) saw unexpected unemployment combine with a big jump in childcare, healthcare and housing costs. This resulted in a burn rate that forced us to make a series of changes, and choices, which proved quite useful in hindsight.
Also write out your balance sheet – assets and liabilities.
Include a liability called “deferred tax and agent’s fees“. Estimate this liability as 6% of the gross value of all the real estate you own plus 25% of all the capital gains in your portfolio (exclude the exempt portion of the gain on your primary residence). Making this number real will help you avoid incurring unnecessary expenses by tinkering with your assets.
“If you want to determine the nature of anything, entrust it to time: when the sea is stormy, you can see nothing clearly.” Seneca — Daily Stoic (@dailystoic) May 5, 2020
I noticed that Buffett sold out of airlines, completely. Elsewhere, I read about his concern about being an owner of businesses that consumed cash.
The quote above is another Buffett/Munger point => how difficult it is to wait, watch and be patient.
The challenge of no-action, waiting for the sea to calm => made easier by a combination of cash-generative assets and cash.
I was asked for my opinion about inflation/deflation.
Before offering thoughts I want to share a portfolio. The ratios can be tailored to your personal situation.
Net Cash Generative Real Estate [See Note 1, below] => 2 years core cost of living
Equities => 3 years core cost of living
Bonds/Cash => 2 years core cost of living
Recourse Leverage => none
(a) I like to think in terms of “years” because it provides a big incentive to keep my spending aspirations modest. (b) The 3:2 ratio, above, implies a 60:40 equity/bond portfolio. (c) Core cost of living => cash it takes you to survive one year.
Pause and think about the above portfolio in deflationary, as well as, inflationary environments.
The portfolio is not optimized for any scenario, there are aspects that will get hit hard. This is OK and to be expected.
Get yourself to a position that’s “good enough” and lets you sleep at night => then go out and focus on living your life as best you can.
Pay careful attention to decisions that impact time, rather than money => time you have in your week, time you have in your life, the quality of your time and what you will spend your time thinking about.
The portfolio need not contain solely financial assets: education, time, youth and other options are important sources of family wealth.
About the likelihood of hyperinflation and depression-style deflation…
…the levers are being pulled different directions by governments, corporations, consumers and central banks
…the levers impact the price of goods, services and capital in different ways
The system is complex and opaque, with feedback loops, 2nd and 3rd order effects => the system is fundamentally unknowable => I should constantly remind myself of the truth of unknowability and avoid people who have a vested interest in impairing my thinking.
my most challenging work is increasing human capital via home school, while modeling a strong marriage for my kids; and
not decrease human capital by becoming a casualty, myself!
I’ll end with a picture of what I saw when I came downstairs this morning.
One of the two best investment decisions I made in the last 24 months was renting in Vail. The other solid decision was not redeveloping a site, at a time when people were making (on paper) $1 million per flip with high-end renovations.
Capital, used wisely, gives you to ability to not-act and be comfortable sitting in an enviable position.
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