Netflix's Junk Bonds Explain How We Are in a Corporate Debt Bubble
jumpstartbk.com
jumpstartbk.com
For those of us in the tech industry accumulating absurd salaries, what do we do to defend our wealth? Normally when inflation is coming, I'd think real estate or commodities would be a safe bet, but they're already in a bubble. It seems like jumping into them at this point might be better than nothing, and maybe that's all we can hope for at this point in the economic cycle?
A burger at a nice restaurant in Seattle can now cost you $18-$20. Maybe we're already in an era of more intense inflation and just don't realize it yet.
Honestly, I work in tech and have a large, fixed alimony payment, so I could personally use some inflation.
Are you sure the price increase is really because of the cost of chocolate increase or the rent of Target within your area or labour of your area increased?
But there are tons of different groups that track inflation and all of them come up with pretty much the same answer. There isn't much inflation right now.
https://www.macrotrends.net/2488/sp500-10-year-daily-chart
Money is created by the central banks but it doesn't instantly appear in people's pockets as cash. That would be required to create instant consumer inflation but the path is much more winding than that.
The money goes into the financial system primarily via banks and bond purchases. CBs buying up debt then gets translated into share buybacks, share buybacks push up stock prices, higher stock prices make the middle class feel more wealthy and so they spend more on middle class things like houses, pushing up house prices, higher house prices get translated into more income going to builders and builders buy things at the store. Traditional measures of inflation like bread or chocolate bar prices are at the end of a very, very long pipeline of money.
It makes for long, but delightfully rewarding reading. Ray Dalio's thinking on the subject is also worth checking out
https://www.linkedin.com/pulse/world-has-gone-mad-system-bro...
And you can get his free book on debt cycles here:
As far as I can tell its essentially just a useless hobby unless you have significant savings. The only people I know that are into stocks are also into things like horse racing etc, and they make/lose about as much from it.
At least in my country the stock market is basically you're retirement fund unless you're one of the few people with a Government pension.
Most companies here offer a matching program to invest for your retirement. This is dumped into the stock market for general growth, with the idea that it's there when you retire.
https://www.politifact.com/california/statements/2018/sep/18...
I would add that there is so much total stock wealth, even though the top 10% own 84% of said wealth, the remaining amount is very very large.
I just can't imagine many people following the financial market with any interest.
You don't have to actively follow the stock market to be an owner of stocks. Buying and holding index funds or mutual funds in general is a great way to build wealth with little effort. Many households in the middle class are stock owners through this method. Most large employers offer retirement plans that include this.
401(k) investments, on the other hand, are available and pushed heavily onto nearly everybody with a white-collar job. And 401(k) investments are stocks. So a huge percentage of people hold stocks, or at least funds which contain stocks.
It's often mentioned that one of the biggest investors in the US (and I assume the world) is CalPERS, which manages pensions for California state employees. You may not be particularly in tune with the stock market just because you have a state pension, but indirectly it matters to you.
On the other hand, if you aren't expecting a recession and are only worried about inflation, probably better to just stay broadly exposed to the stock market (low cost index funds). And if recession is your only concern, then cash or safe bond funds would probably be the best bet.
Personally, I am not too worried about inflation. If you look at where the strongest growth has happened in the last decade, it has been largely concentrated into a handful of 'super' cities (SF, Seattle, etc...) plus China. In the case of the latter, density puts downward pressure on consumption (you can only fit so much crap in a small apartment). And China's 'consumer class' has yet to really materialize. The one caveat, is that due to the wealth imbalance, I think we have seen inflation in things that wealthy people buy (real estate, stocks, art, etc...). But post-globalization, it will likely take a really broad surge in consumer demand to move the needle.
[1] https://www.treasurydirect.gov/indiv/products/prod_tips_glan...
A slowing economy would only slow money velocity.
Incredibly the inflation has been limited to only a few assets.
If we do see a spike in inflation watch out for housing prices to plummet. It won’t necessarily make them any more affordable because a mortgage payment of $3000 per month stays the same borrowing $500k at today’s rates or $200k at 10% interest (made those numbers up, but you get the point).
Only amongst right-wing politicians and their economic lackeys.
People who actually looked at the models concluded it was nothing to worry about:
> Except that those who knew their Hicks declared that this time was different, that in a liquidity trap the rise in the monetary base wouldn’t be inflationary at all (and that the relevant history was from Japan since the 1990s and from the 1930s, which seemed to confirm this claim). And so it proved, as shown by the red marker down at the bottom.
* https://krugman.blogs.nytimes.com/2015/05/17/money-inflation...
A 2000 paper explaining Japan, monetary supply, and inflation:
> Those who use Hicks's famous diagram as the point of reference for evaluating monetary policy will recall that at some low rate of interest the horizontal portion of the LM curve emanating from the vertical axis is meant to represent the lack of influence of expanding the money supply on the rate of interest; monetary policy thus does not shift the intersection of the LM curve with the IS curve that determines the equilibrium level of output. Since monetary policy has no impact on the level of output along this horizontal portion of the LM curve, debt financing of government expenditure remains the only policy capable of influencing output.
* https://papers.ssrn.com/sol3/papers.cfm?abstract_id=219494
In 2009 US entered the same situation Japan has been in since the 1990s ('zero' interest rates), and so the knowledge was transferable across the Pacific to those who weren't blinded by political ideology.
The liquidity trap goes back to Keynes:
Though there were for the general housing bubble:
> In July 2001, Paul McCulley, an economist at Pimco, the giant bond fund, predicted that the Federal Reserve would simply replace one bubble with another. "There is room," he wrote, "for the Fed to create a bubble in housing prices, if necessary, to sustain American hedonism. And I think the Fed has the will to do so, even though political correctness would demand that Mr. Greenspan deny any such thing."
> As Mr. McCulley predicted, interest rate cuts led to soaring home prices, which led in turn not just to a construction boom but to high consumer spending, because homeowners used mortgage refinancing to go deeper into debt. All of this created jobs to make up for those lost when the stock bubble burst.
> Now the question is what can replace the housing bubble. [...]
> But although the housing boom has lasted longer than anyone could have imagined, the economy would still be in big trouble if it came to an end.
* https://www.nytimes.com/2005/05/27/opinion/running-out-of-bu...
And then 2007-8 happened.
The reality is very different though. Bonds are how most large companies finance themselves. And when they can issue a bond that people buy for < 5% yield, it's almost like free cash. Assuming in 2027 - Netflix has say conservatively 220M members paying an average of say $11 (which is less than the average price today, not accounting any price increases). That will be a whopping 29B in revenue. Way more than enough to pay off debt + some in a single year. This is even after accounting for a massive spend on making movies. For context Disney+ spent 1B this year and planning to spend up to $2.4 billion by 2024.
"I came out of school during the Recession of 2018."
They state:
>Higher rates mean higher returns. A junk bond historically hovered around a high yield of 10%. This attracted investors to the bond despite the risk of the company defaulting
Broadly true, but it's the spread above the risk free rate that is important. If US government bonds yield 15% and some BB rated bond yields 16%, one would be unlikely to invest it in regardless of the high absolute yield.
That differential is called the credit spread - the amount you are paid in excess of the "risk-free" rate to take the credit risk of the bond issuer (i.e. the risk that they don't pay you back). The reason BB bonds are at 4% is not because the credit spread is at a historic low, but because the risk free rate is around 1.5%.
Current BB spreads are low, around 2.5%, but not historically so. They were at 2% in the late 90's, at the current level in the mid 2000's, and actually haven't moved a lot in the last 2 years. This earlier period is the time the author refers to when absolute BB yields were ~10%:
Spreads:
https://fred.stlouisfed.org/graph/fredgraph.png?g=q4Up
Yields:
https://fred.stlouisfed.org/graph/fredgraph.png?g=q4UD
Ps: The St. Louis Fed FRED site is excellent!
This QE insanity has gone on for far too long..
And for the rich.. don’t worry about your assets. The next president will bail you out first.
In fact, the fed ended up turning profit, as the banks healed, and the fed sold its part.
those "owners" got their assets froze until the situation became under control, and the fed got its money back.
All these complaints about savings big banks are just extremist (both commies and libertarians complain about it) FUD. If banks were not saved, the economy, the middle class and the poor would be far worse.
and as grandparent said
>Shareholders took huge losses in the bank “bail-outs” in 2008
Shareholders are by definition "who owns". Sure there are both Billionaires and middle-class shareholders, but if you have a bigger % of shares, you have a bigger loss.
It’s not much of a market when the government bails you out with tax payer money, to the detriment of everyone else.
And then, they kept making one mistake after another and another. And here we are.
Homeowners were bailed out indirectly by the type of banking 'bailout' that doesn't get talked about - the fact that the Fed was willing to accept garbage mortgages at face value as collateral for cash.
A home with market value of $100K, mortgage at $200K - meaning a -$100K value ... was accepted at the Fed at '$200K' in return for cash. This wiped out the toxicity from bank balance sheets and allowed them to operate normally. The idea being in the future, when housing was re-inflated, the banks would eventually have to 'take back' those crap housing assets.
Can you imagine if other businesses were allowed this kind of special facility? And it was not a small thing, it might be the biggest chunk of asset movements literally in the history of the world - it doubled the size of the Fed's balance sheet very quickly.
The USD used to be backed by TBills, i.e. the US government ability to pay. Now, the USD is backed 1/2 by crap mortgages.
Can you imagine any other country getting away with this? If Greece did this, the currency would crash and they'd be devastated.
This is the power of supposed 'trust'.
Speculators, flippers, subprime ARM borrowers drove the cost of housing up. Housing was seen as an investment, not as a place to live in.
After the crash, the Fed reduced the interest rate to historical lows, and allowed lots of housing to be bought up by corporations, or groups of individual investors. When a bunch of investors join forces, they can easily buy practically any property. You and I as an individual, cannot. Our salaries don’t bring home enough money.
On top of which, what about the young millennials that want to start a family? They were devastated after the 2008 meltdown with massive layoffs. Then they are priced out from housing now, with the historical highs. And they have massive student loans, and some have mediocre jobs to pay back those loans. So they’re smacked on both ends.
Now, we have a social problem. Families are delayed. People delayed marriage. Couples delayed making children. The women in their 20s got older, and delay childbirth into their 30s, if they even have children. And the risks of genetic defects goes up. Now, the responsible people that you want to procreate and have children, are not bearing children.
As a society, those in power and authority, and those with the financial wealth, just gave this a collective shrug: “Not my problem. Every man for himself.”
Then they kept making more mistakes. Low interests fuels investors speculation. Housing is not being built. Home sale prices begin rising rapidly. Rents go up to match. QE Infinity keeps fueling this massive bubble.
Those millennials again, that society needs to buy a house, and to begin building stable communities, had their salaries eaten up by rising rents.
And now here we are. The starting price for a home is now $700,000. How does a young couple afford to start a family, when a starter home is that high? I don’t know. Nobody cares. Everyone is out for themselves.
In retrospect, the better solution was to not bail out the homeowners, since they were speculating anyway. And to kill the notion of seeing housing as an investment vehicle, thereby making potential investors shy away from buying properties.
This could’ve normalized the housing market, and allow those that should be in a home, to have a home that they can own.
But I don’t see this ever happening. The masses are now slaves to paying off a massive $700,000 mortgage that they will work over 30 years of their life to pay off.
We will need a revolution to change this.
That would have led to existential destruction of the economy from which recovery would have taken decades.
So - the bailouts, immoral as they may be - were a better options.
But yes - interest rates should probably be nudged a little higher, and mortgages should be of much higher quality etc..
One trick would be to get rid of mortgage interest as a deduction. That's crazy. Of all the things we are making tax-deductible? Mortgage interest? Wow.
I don't like bubbles, obviously, but don't be so thrilled about bubbles bursting and "taking everyone down with them".
Life becomes miserable for a lot of people when bubbles burst, and frequently it becomes way more miserable for people that aren't responsible for the creation of these bubbles.
Suicides rates, depression rates, etc. go up.
This current trajectory is not sustainable.
So when you say — “we need a real correction” and “not sustainable”. I’m curios — what exactly is not sustainable, and why a correction will make it more sustainable? Why do we “need” a correction?
1. resources are not infinite
2. human creativity is basically boundless, but it needs time
3. humans tend to think alike and to get excited about the same things at the same time
We find a better way to manage resources, everybody hopes it will cure cancer, provide world peace, etc. As a result investment skyrockets, the "new way" develops and helps everyone but inevitably it doesn't do everything people investing a lot of money were hoping it would do. So people pull their money back and get scared when they realize how much they risked. People spend less money and things enter a downward spiral.
What happens when the bubble bursts? What doesn't lose value? Who doesn't wind up underwater?
I remember that for a short but intense period of time money-market funds were in negative territory in late October 2008, which was really interesting because they were seen as basically cash (rightly or wrongly, that’s another discussion) and a run on them would have made many people very, very unhappy.
The fact is that gold is one of the few asset classes that are safe.
As opposed to say steel and copper which are tied to industrial supply and demand.
Everything.
"What happens when the bubble bursts?"
Good question. High inflation? Strong recession? Or decades of stagflation? Everything is possible. The future is hard to predict.
"What doesn't lose value? Who doesn't wind up underwater?"
"No place left to hide".
I assume OP is alluding to low interest rates, lots of money being injected in to the system and a select few companies being priced silly high.
There's no such thing as 'underlying worth' :)
A bubble is when prices are high relative to historical or comparative measures of worth, and any degree of volatility can snap such valuations back to historical norms.
The thing is - prices can be way out of historical norm ... but it may not be a 'bubble', in the sense that it may take a lot to 'prick' the bubble or change things so that there's a crash.
Housing in 2008 crashed due to a bunch of things gone wrong. If any one of those things held up ... there may not have been a crash even with high valuations, even with a fair bit of shenanigans going on.
As far as I am concerned, interest rates are being held 'historically low' by the Fed. In any other recovery, the'd have gone up by now.
The FT reported however that the Fed is engaging in a new tactic: they are looking not just at unemployment, but those who have stopped seeking work as well. Though unemployment is low, there's still people being sucked into the labour market and they're trying to see how far that can go. So they are less worried about inflation than they are 'true unemployment' apparently.
The primary function of an asset is to generate income - through dividends, rent, bond interest etc. This income determines asset's underlying worth.
Even if they did, what is a single share that produces $1 a month 'worth'? It depends on your cost of capital.
In both cases, they are 'worth' what someone will pay for them :)