Monthly Archives: September 2019

Does The Inversion Of The Yield Curve Signal a Recession?

An inverted yield curve is one of the few indicators that before have always correctly signalled an upcoming recession. An inverted yield curve happens when the yield on 10 year treasuries is below the yield on 2 year treasuries (sometimes called the “2s10s”). The 2-10 year yield curve is the most common people view. Currently the 2-10 year yield curve is positive after it turned negative for the first time since 2007 at the end of August.

Yield Curve Inversion
Yield Curve Inversion

In the past a negative yield curve has always signalled that a recession could happen in the next 1 to 2 years. Note from the chart below that the curve can be at or below zero for a long period before a recession happens. Furthermore from the chart it looks like a rapidly steeping yield curve signals a recession is close.

Yield curve inversion long term chart
Long term chart of the yield curve

The question arises will an inverted yield curve signal a recession this time? A big difference in my opinion with other times is that this time the yield curve is watched by a lot of participants in the market and so a lot of stories are published about it.

Stories mentioning "yield curve"
Stories mentioning “yield curve”

From the mainstream media such as Drudge Report.

Drudge report yield curve inversion recession
Screenshot of the frontpage of Drudge Report on August 14, 2019

To the president of The United States who even talks about a “crazy” inverted yield curve.

Donald Trump President of The United States Tweets on the Yield Curve Inversion
Tweets from the president of the United States Donald Trump mentioning the yield curve inversion

And even members of the Federal Reserve such as Atlanta Federal Reserve President Bostic (picture below) and Neel Kashkari (in a post on Medium here) the President of the Minneapolis Federal Reserve are openly talking about the inversion of the yield curve and what it means for the economy.

Federal Reserve Bostic Yield Curve Inversion
Headlines from Fed’s Bostic on May 16, 2018

It remains to be seen whether the signal works this time.

Forward P/E And 10 Year Returns

Since 1988 stocks have always produced a negative 10 year return when the Forward Price to Earnings ratio was 22 or higher. This chart says nothing about 1 year returns. Then returns are all over the place whether the Forward P/E is 12 or 22. Although you can see from the chart that positive returns are lower 1 year out compared to when the Forward P/E is lower.

This data is for the US and I have no idea what these charts would look like if you would take an index like the Nikkei 225 or a European index such as the Euro Stoxx 50 or the AEX Index.

Forward PE and 10 year returns
Forward PE and 10 year returns

If you invest on a long term basis the lower the Forward P/E for the market the better your return could be.

Forward PE and 1 year returns
Forward PE and 1 year returns

As of the end of June 2019, the Forward P/E for the S&P 500 is 16.9. This was above the average of the last 30 years. This average is skewed to the upside though because of the extreme valuations during the 2000’s Dot-com bubble in stocks.

S&P 500 Forward PE ratio
S&P 500 Forward PE ratio

Dutch House Prices Are Rising Slower

The Dutch Statistics Bureau CBS came out last week with a new monthly update on Dutch house prices. The data is showing that the speed at of which house prices in The Netherlands are rising is slowly declining.

Meanwhile the Dutch government has come out in the past few weeks with changes to the taxing of property investments in box 3 (investment properties will be taxed higher) and it has proposed a new law which will limit the amount of the WOZ-waarde (the value of a home used for taxation purposes) to be used as points to calculate whether a house will be classified for rent control or not. These two changes could potentially have a big impact on the prices of Dutch homes.

At this moment Dutch house prices were 5,7% higher in August 2019 than a year before. This is down from the 9,5% year over year growth of prices in November 2018.

Netherlands Average House Prices Year over Year Percentage Change
Netherlands Average House Prices Year over Year Percentage Change (CBS)

The average sales price of Dutch home has risen to a price of € 316,000. At the bottom in June 2013 the average sales price of house in The Netherlands was € 206.000. From the bottom in 2013 prices have risen a total of 53%.

Netherlands Average House Sale Price (CBS)
Netherlands Average House Sale Price (CBS)

The rise in prices has led to a decline in houses that are sold per month. As can be seen in the two below charts the amount of houses that are sold each month has been declining. This is also partly caused by a shortage of houses in the Netherlands.

Netherlands Houses Sold Year Over Year Percentage Change (CBS)
Netherlands Houses Sold Year Over Year Percentage Change (CBS)
Netherlands Amount of Houses Sold per Month (CBS)
Netherlands Amount of Houses Sold per Month (CBS)

At this moment the value of all houses sold in the Netherlands is not showing any signs of weakness but a drop can happen suddenly as the below chart shows.

Netherlands Value of Houses Sold per Month (CBS)
Netherlands Value of Houses Sold per Month (CBS)

The 1980’s Japanese Stock Market Bubble

The Japanese stock market was booming at the end of the 1980’s. The Nikkei reached a high of 40,000.

Long term chart of the Nikkei 225
Long term chart of the Nikkei 225

Because of this boom, Japanese companies were among the most expensive companies in the world. This led to a lot of Japanese companies buying up foreign companies. Newsweek came out with this cover in 1987 capturing the zeitgeist of that time. This zeitgeist was later also captured in the movie Die Hard (the company at the center of the movie being Japanese).

Newsweek 1987 Cover Your next boss maybe Japanese
Newsweek 1987 Cover: Your next boss maybe Japanese

Ultimately the bubble burst and Japanese stocks entered a bear market. Stocks crashed almost 90% from the top and the Nikkei reached a bear market low in 2009 during the credit crisis. Japanese stocks are up 350% since then but still almost 50% below the all time high set almost 30 years ago. Japanese stocks to this day have not yet recovered.

One other way that shows how big this bubble was is how large the market capitalisation of Japanese stocks was as a percentage of global stock market capitalisation.

Japan market capitalisation as a percentage of global market capitalisation
Japan market capitalisation as a percentage of global market capitalisation

Berkshire Hathaway’s Apple Stake

Berkshire Hathaway and Apple are currently the second and fifth company in the S&P 500 by weighting in the index. The market capitalisation for these companies are currently $ 980 billion for Apple and $525 for Berkshire Hathaway.

At this moment Warren Buffet’s Berkshire Hathaway holds a $ 50 billion stake in Apple. This position is 5% of the market capitalisation of Apple and more interestingly 10% of the market capitalisation of Berkshire Hathaway. The stake in Apple is 25% of Berkshire’s equity portfolio. Meanwhile Berkshire’s has hit the enormous amount of $ 122 billion in cash.

S&P 500 top 10 holdings
S&P 500 top 10 holdings as of September 12, 2019

Berkshire’s performance over the years has been stunning, as I’ve posted before. In euro’s though, the performance is even more stunning the last decade since the effect of the dollar gaining in value has added to performance.

Berkshire Hathaway B in Euro
Berkshire Hathaway B in Euro

Historical View Of Federal Reserve Balance Sheet

The balance sheet of the Federal Reserve has been big in the past as can be seen in the below chart. This chart depicts the balance sheet to GDP ratio of the Federal Reserve from 1913 till 2012. The Federal Reserve was created in the year 1913.

After the crash of 1929 the balance sheet had to be increased in order to save the economy. The balance sheet to GDP ratio hit a high of 23% right at the start of World War II. Since then it had slowly trended lower to 5% of GDP until the financial crisis of 2008 hit.

Historical View of Federal Reserve Balance Sheet
Historical View of Federal Reserve Balance Sheet

Here is a chart which has the balance sheet since today. As can be seen from the chart is that the Fed’s balance sheet started rising after the financial crisis and hit a high of $ 4.4 trillion in 2014 when the Fed ended the QE program. In 2018 the Fed chose to unwind the balance sheet.

Federal Reserve Balance Sheet 2003 - 2019
Federal Reserve Balance Sheet 2003 – 2019

Right now the Federal Reserve balance sheet to GDP ratio sits around 18% after having hit a high of 25% in 2014. This is explained by the Fed unwinding the balance sheet from 2018 and the rise in US GDP.

Federal Reserve Balance Sheet to GDP 2003 - 2019
Federal Reserve Balance Sheet to GDP 2003 – 2019

Are Buybacks The Main Driver For The Rally In Stocks?

A fascinating chart I came across on Twitter. Since the financial crisis around $ 3 trillion has been flowing in to passive index funds which typically have a lower fee than active funds. But what is interesting about this is that there have been no net inflows in US stocks since the financial crisis.

All the money that has flowed into passive index funds have been offset by an outflow of actively managed funds. In fact, there is actually $350 billion less in US equity funds (both active and passive) than before the financial crisis.

Cumulative US Equity Fund Flows
Cumulative US Equity Fund Flows

At the same time the S&P 500 is up 300%. Even more when dividends are factored in.

S&P 500 from 2003 till September 2019
S&P 500 from 2003 till September 2019

So why then are stocks higher if demand from investors in funds actually down $ 350 billion over the last decade?

Buybacks

The answer could be because of demand for stocks from buybacks. Buybacks have become more popular since the financial crisis. With buybacks a company uses its own money to buy back its own shares in the market. Buybacks are popular because they are a very tax efficient way to generate shareholder value.

When a company performs a stocks buyback program the company buys back their shares on the stock market. This way the amount of outstanding shares is reduced. Remaining shareholders will share their profits with less shareholders. This should lead to an increase in the price of the remaining shares.

If a dividend is paid out a tax must be paid in this received dividend. A capital gains tax only has to be paid when the shares are sold. So during the period which an investor holds his shares no taxes have to be paid (which is different from when a dividend is paid).

S&P 500 Quarterly Buybacks
S&P 500 Quarterly Buybacks

The Greatest Asset Bubbles In History

The chart below depict some of the greatest asset bubbles of all time. Among them are the Dutch Tulip Mania and the Mississippi Company bubble. The bubble in gold in the 1980’s and the 1929 stock market bubble look tiny compared to those two bubbles.

The tulip bubble record was set in 1637 and has been beat recently in 2017 by the bubble in Bitcoin. Bitcoin was first introduced around 2009 for a few dollar cent per Bitcoin but the price quickly rose to an all time high of $20,000 per Bitcoin in 2017.

The greatest asset bubbles in history (Bitcoin bubble, tulip bubble, Mississippi bubble, South Sea bubble, Gold bubble, 1929 stock market bubbel)
The greatest asset bubbles in history

Back in 2013 I wrote on this blog how the price action in Bitcoin looked like the price action expected of an average bubble. That was way to early (Bitcoin was only trading around $60 back then). Bitcoin and other cryptocurrencies such as Ethereum and Litecoin ultimately reached their peak at the end of 2017.

Since then the price of Bitcoin dropped from $ 20,000 to around $ 3,000. A drop of 85%. Which can be expected to happen when a bubble pops.

The chart above is showing something different from what normally happens after a bubble ends though. The price of Bitcoin has been steadily rising from the low of $3,000 in 2018 till almost $ 14,000 in 2019. Right now Bitcoin is trading around $ 10,000.

Maybe Bitcoin has more room to run and we haven’t seen the all time high yet?

Bitcoin 1 Year price: September 2018 - September 2019
Bitcoin 1 Year price: September 2018 – September 2019

U.S. House Prices vs. the S&P 500

Is investing in real estate more profitable than investing in the S&P 500 over a long period? This long term chart shows that for much of the last century investing in the S&P 500 returned much greater returns than investing in real estate did. This chart only misses one thing in my opinion. This chart does not show possible rental income and the re-investment of this rental income in other houses. At the same time it also doesn’t show possible costs and taxes associated with homeownership and thus with investing in real estate. Nonetheless it is a nice chart to view.

US House prices vs. S&P 500 long term
Long term US House Prices vs. S&P 500

Here is another chart showing US house prices from 1987 till April, 2019. This is the Case Shiller Index.

Case Shiller National and Composite Indices Nominal
Case Shiller National and Composite Indices

Here is the same Case Shiller index with year-over-year percentage change until April 2019. This chart is showing that the rise of house prices has declined the last few years. A cause for this has been the Federal Reserve which has raised rates from 2016 till 2019. This has caused mortgage rates to rise over that same period.

Case Shiller National and Composite Index year-over-year percentage change
Case Shiller National and Composite Index year-over-year percentage change

Here’s a chart of the average fixed rate on 15 year and 30 year US mortgages. It will be interesting to see whether the drop in rates will lead a pick up in house prices later this year. From the end of 2018 mortgage rates have been dropping lower as it has been anticipated that the Federal Reserve will lower rates (which they have done with 0.25% in July, 2019.

15 Year and 30 Year Fixed Rate Mortgage Average in the United States
15 Year and 30 Year Fixed Rate Mortgage Average in the United States

The Herengracht Index

Here’s two different charts of the Herengracht Index. The Herengracht Index is a very long index showing the value of house prices along the Herengracht in Amsterdam. The Herengracht is a street in the center of Amsterdam alongside the Herengracht canal and has since the beginning of the 1600s always been a street on which people have been eager to live.

“The Herengracht has been dug in three phases, of which the first was in 1585, the second in 1612, and the third in 1660. By 1680, nearly all the lots on the canal had been developed. The properties built during the first development phase between 1585 and 1612 were relatively small and insignificant, but from the second construction phase in 1612, the Herengracht was meant to be the most fashionable and beautiful of all the canals in Amsterdam. It has been Amsterdam’s finest location until present times.

Nearly all the properties on the Herengracht practice of trades was prohibited, many also were for residential use, but, although the contained the office of the owner. In this century, the buildings along the canal have been increasingly put to use as offices, especially in the more expensive areas. The first building specifically constructed for office use dates from 1858, while the first time an existing building was transformed into an office was in 1808. Especially in the first half of the twentieth century were many properties transformed into offices. For all properties, ownership of the building and the land on which it stands go together.

The number of properties has gradually decreased over time. Originally, there were 614 lots, but already during the first development phase, lots were combined to allow for the construction of bigger buildings. This has continued until the present, and there are now some 487 properties.” Source: A Long Run House Price Index: The Herengracht Index, 1628-1973

Herengracht Index

Herengracht Index

Herengracht Index

Herengracht Index

Herengracht Amsterdam overview
Birdseye view of the Herengracht in the center of Amsterdam