Soon Government Will Be Incentivized To Have Higher Interest Rates

For the moment, the Fed remains leading the charge to hold interest rates low, based on what I would say is a faulty premise that the US economy just needs more expensive homes and homeowner tax income to get out of the hole it finds itself in.

The primary advantages of low interest rates are:
1) Cheap borrowing/refinancing, taking pressure off consumers
2) Allegedly easier to acquire homes, raising tax receipts (except for banking restrictions on lending)
3) Increased home sales enable retirees to downsize without collapsing pricing/bankrupting themselves
4) Support prices of goods and services, avoiding debt spiral

Each of these virtues, however, comes at the assumption that the consumer had the leeway to borrow more, and would take the pause to put themselves on solid footing, paying down debt and restructuring. Cheap credit was (and is always) supposed to be a momentary stepping stone to a better tomorrow.

In reality, it always becomes a game a chicken.

Consumers haven’t repaired their savings accounts at all. Debt levels should be something like three quarters of what they are – we’ve had near zero interest rates for five years and banks have so many programs running to help consumers pay off loans, it’s ridiculous. But it hasn’t happened. Consumer finances remain horrible, the money has largely been spent in ways that haven’t strategically benefited the recipients, and the low interest rates have seeded a newer, more dangerous problem.

The nation’s retirement system is on the rocks.

Looking at the state of public pensions and private 401k’s, the baby boomer’s retirement is in peril. Misallocations into housing and malinvestment have taken their toll. This isn’t exactly breaking news.

However, heretofore the assumption has been that the Fed’s knee jerk reaction to keep rates low was the only pathway and that there would be no push to counter this until unemployment levels and economic prosperity returned.

I would suggest that within the next few years, as baby boomer retirement heats up and the ability to create a virtuous cycle built on higher home prices and cheap credit slips away, the pressure on the Fed to maintain low rates will actually begin to cave to a growing murmur from the crowd demanding higher rates to maintain retirement obligations.

While this move will be a death knell for economic growth, from the point of view of aging boomers (the reigning political powerhouse and largest voting segment) economic growth would be a hollow victory as their own retirement obligations come under pressure and we increasingly see benefit cuts, such as are being witnessed in Detroit or California. Maintaining the status quo at the expense of economic growth puts them ahead, as they have a larger share of current goods and services, whereas permitting growth would ultimately lead them personally to greater poverty.

High interest rates takes pressure off of pension systems, and enables savings accounts to grow rapidly (such as those of boomers who have taken the final steps of downsizing homesteads and transferred much of their wealth into fixed income investments). It also improves quality of life for those savers by putting pressure on pricing.

Within three to five years, I expect interest rates get pushed up above 6% annually, for the purpose of refinancing retirement accounts for the benefit of boomers, at the expense of the rest of the country (planet?). When this occurs, I don’t think it will be because the Fed has lost control of the bond market. I actually believe it will be done intentionally, driven from political expediency.

Tesla is running again today, up 7% because some analyst report came out trumpeting the stock on the back of Model S deliveries.

Effectively, what Elaine Kwei has said here is that since she thinks Tesla may have delivered a few more Model S’s than forcasted (how many?) and that since she believes Tesla can sell more than 21,000 vehicles for all of 2013 (a few hundred more? A few thousand more?), that Tesla should be worth $130 a share.

Using a 10 year discounted cash flow approach, she somehow worked out this value for the company. Here’s what she didn’t say.

In order to believe this number, Tesla earnings per share would have to grow at 60%-70% per year to break even, with a 10% normalization after that to justify them being priced at $130 today.

Let’s pretend for a second that I buy into this concept which has electric vehicles taking over the country inside of a decade, based on the technology and real world costs we have to work with right now.

Alright – well if Tesla “only” manages to grow at 40% per year, then the stock wouldn’t become worth what this woman is pricing it until 2028.

Do you see the problem here? Still astronomical growth rates at anything less than the 30 meter high bar these people want Tesla to jump over adds time-risk to the equation measured in the half decades.

If Tesla is more of a normal “tech” growth company and pulls 20% EPS growth year over year? That puts it at fair value sometime in the year 2040.

And if Tesla is a 10% annual growth company, then you’ll be looking at breaking even around 2065.

Discounting future cash flow is a horrible method; I don’t know why it hasn’t been thoroughly discredited at this point. It flies in the face of salt-of-the-earth good advice about not counting chickens that haven’t hatched yet. Especially when you’re trying to target these high growth numbers on a company with no real track record, if the good folks at Jefferies have overlooked anything or the unexpected should crop up (as it almost assuredly will), you’re talking tacking on an extra 30 years for being a sucker today. That quadruples the risk folks.

Exponential functions are real terrifying like that…

Keep in mind, the US has averaged a recession about once every decade since the 60’s. Whether it was the Nifty Fifty, the savings and loan crisis, the ’87 crash, oil embargos, unexpected wars, tech market explosions, LTCM smart guy eff ups, housing epidemics,…life never goes as planned.

You can get away with betting stocks act perfectly for about 6 months into the future. You might even get lucky for a year or two. You bet 5 years out that behavior will be constant and you’re pushing it. 10 year bets are usually acceptable when dealing with 2X book, 10x EPS companies because there are average cost chances to get you back to even quickly.

But if you’re buying Tesla at 120x EPS right now, you’re betting that for the next 10 years, the company can basically double year over year without any competition, any economic headwinds, any unforseen problems, any variation from “perfection”.

If you get this wrong, the resulting selloff won’t be “recoverable”. There’s no averaging in you could possibly engage in that will save you in this lifetime.

We are in classic South Sea Company levels of hyperbole here.

For those of us in our 30’s or 40’s, if Tesla stumbles, you’re looking at being in your 70’s or 80’s before you find a recovery. I’d say you have fairer chances of flipping open a mortuary table and betting on whether or not you’ll even be alive by then.

Looking at their current EPS, I’m thinking a price closer to $20-30 is more fair. That puts them at about twice book value (expensive for an auto, but hey it’s a compelling story). You could maybe put up $35-60, a price range which has them moderating to 20% EPS growth after being blessed with a decade of 40% annual growth – which is still a pretty compelling valuation, if you’re being honest with yourself.

Mind you I wouldn’t pay that because I don’t believe that electric vehicles are the future. My personal price where I would maybe think about tipping in is about $10. But listening to the stories you lot are weaving, the price you should be paying is at least half of what you’re doling out right now. Probably more like a fifth, to be direct.

The Fourth of July is upon us. What kind of unpatriotic soul are you, calling for market panics in the middle of celebrating the very special brand of American Imperialism?

My dear friends, we have barbecuing to be getting to, next week. Friends and family will be invited over. Politics, sports and gentlemanly arguments need to be partake of. I should think the 9th floor will only be in business on an open door policy; and without any real driving force of purpose.

The market will melt up to celebrate this great country and as a show of indifference for the countless drabs we UAV, blackmail or step on to maintain order in this circus tent called Planet Earth.

Since the selloff managed to shore itself up, I do not expect next week to be anything other than jovial and festive. The correction can resume afterwards.

I’ve been sleeping on several issues that impact my two multifamily companies (AEC and CLP).

These issues are the effects of higher interest rates as they determine mortgages, the subsequent demand for rental units, and the ability of the space to borrow money to finance growth.

It’s a pernicious structuring, for sure. No easy answers here; as the effects seem to run counter to one another and can vary immensely depending on who you are and what your positioning is.

However, my general feel for the situation is this:

For the moment, financing for multifamily/REITs is generally secure. Conservatives are salivating to dismantle Fannie and Freddie, and the public probably concurs with those sentiments, but that would strike at the heart of liberal incentives. So any attempt to reform those institutions will probably be shut down or deflected.

However, this financing is set to get more expensive, if bonds keep rising. If you’re a company saddled with debt, this could cause all sorts of trouble. I remember back when I was first perusing through the space for purchases, I saw a lot of multifamily REITs that were knee deep in loans with bad cash flow and not enough on the books. If financing for apartment construction goes up and you’re holding the wrong companies, growth will go out the window and these badly situated players turn into takeover targets for the best of breed.

Meanwhile, there will most likely be shown to have been a small upsurge in housing purchases this last month. Players on the sidelines who became fretful that the window of opportunity was permanently closing likely rushed out to lock in a house purchase. After that surge though, the path to homeownership is getting harder, not easier, with the treasury selloff. This should solidify the 95% occupancy rates these companies have been experiencing, and get any apartment communities they construct filled.

I like AEC and CLP because they have had a vigilance about paying off debt, improving credit ratings, reinvesting into the business, and controlling operations. Their cash positions are well padded, and if push came to shove, they could quickly turn their cash flows on the liabilities, locking the companies down. I’m not worried about either of these two companies getting swept away from higher rates.

AEC just finished their second equity offering, and CLP is busy merging with MAA to make one of the largest multifamily REITs in the country.

Thus, until I see contradictions to these beliefs, I’m inclined to feel that both AEC and CLP will benefit on net from raising interest rates, even though it may momentarily hamper their growth. They are in superior positions relative competitors thanks to smart management decisions. And I am holding firm here.

Q1 GDP estimates were complete hocus, spurred by inappropriate inferences from seasonal adjustments and over-optimism that housing prices can ignite a positive feedback loop, at this point in time.

If it seems like there’s no way you could have known that…you’re wrong.

I told you explicitly that this would happen in January, while also reminding you to be stupid long in the teeth with equities. The entirety of this positioning was predicated on selling out into the spring strength and preparing for reality to set it during the summer; that same time reality always sets in.

How many of you listened?

I’m guessing not many, because in the spring, all of a sudden site traffic plummeted and I literally couldn’t give my posts away.

Incidentally, I also told you you’d be back.

Crawling…

We’re enjoying a relief rally at the moment from oversold conditions. Behind that, there’s at least one more leg lower waiting. We will retrace most of the last four months; first look comes at 1,540 SP for me.

At that point, I’ll make the judgement if we go lower still, or set up for a bottom.

In the meantime, please stop talking about the accelerating growth lines.

Have a quick look at the graph on this site. I haven’t audited any of the numbers, but if the author has done his homework, it fortells fairly clearly what oil longs have to expect.

For the moment, all of my short exposure is being pesteringly resilient; most probably because I am counting on those positions to even out my account. So of course, oil is holding up here, the euro is trying to push higher, and TSLA recovered a $3 move.

There’s no reason for any of those things other than that they hurt Cain Hammond Thaler. The market is trying to harm me, because that is the only consolation anyone in these positions will ultimately have…if they can shake me out.

But I have the patience of sheet rock. You will not win.

Current positions by size (greatest to least)

Cash – 27%
CCJ – 18%
CLP – 8%
AEC – 8%
SCO – 8%
EUO – 8%
Silver – 8%
BAS – 7%
RGR – 7%
January 2014 TSLA 35 Puts – 1-2%