Podcast Summary
Fed's Inflation Strategy and Supply Side Issues: Nancy Davis expresses concern that the Fed's current inflation strategy may not be sufficient, suggesting the need to consider using the balance sheet as a tool to help reduce inflation expectations. CPI remains high, and future rate hikes' pace and magnitude are uncertain.
Key takeaway from this conversation with Nancy Davis is that the Federal Reserve's approach to inflation, as communicated in the Jackson Hole meeting, is a key focus for investors. Davis expresses concern that the Fed's current strategy of only raising interest rates to combat inflation may not be sufficient, as it does not address the underlying supply side issues and labor market tightness. She suggests that the Fed may need to consider using its balance sheet as a monetary policy tool to help reduce inflation expectations. Davis also notes that while the latest CPI print showed a decrease from the previous month, it remains high and personal to individuals, making it an imperfect measure of inflation. Regarding further rate hikes, Davis acknowledges that the pace and magnitude of future hikes are uncertain, with some economists suggesting a potential shift towards smaller hikes. Overall, Davis provides valuable insights into the complexities of inflation and the potential strategies for addressing it.
Market expectations vs. actual inflation: Individuals should consider their personal finances in light of inflation uncertainty, as the impact of rate hikes on inflation is uncertain and future expectations may not align with reality
The markets have already priced in significant interest rate hikes, and inflation expectations are relatively low despite current high realized inflation rates. The Fed's decision to hike policy rates is seen as a way to combat inflation and bring future expectations in line with their target. However, the impact of these rate hikes on inflation is still uncertain and may not be fully realized yet. It's important for individuals to consider their personal balance sheets and the potential impact of inflation on their savings and cost of living, regardless of whether inflation is expected to rise or fall. Future inflation expectations are currently priced low, but realized inflation remains high. The disconnect between market expectations and the actual economy may persist for some time.
Uncertain Economic Landscape and the Fed's Balance Sheet: Investors should consider adding defensive assets due to economic risks, understand their fixed income portfolio's exposure to mortgages and short volatility, and be aware of the potential market reaction to uncertainty.
The economic landscape is uncertain and volatile, with rising inflation, labor market challenges, and geopolitical tensions. Experts suggest investors consider adding defensive assets to their portfolios due to these risks. The Federal Reserve's balance sheet, often referred to as the elephant in the room, is a significant factor. The Fed has been cautious about offloading its balance sheet due to past market disruptions. The Fed's caps for its balance sheet are set to increase in September, leading to speculation about potential changes to mortgage holdings. It's crucial for investors to understand their fixed income portfolios, particularly those labeled as "core," as they may have significant exposure to mortgages and short volatility. When selling options, investors are effectively selling volatility. The market's reaction to this uncertainty can lead to increased volatility, and investors should be aware of their portfolio's risks and composition. Jim Cramer's recent statement about the market being flat after the weekend is an example of trying to predict market movements, which can be risky and may not fully account for the underlying volatility.
Investors face risks from homeowners' prepayment options and policy changes: Investors with short volatility positions may face ball risk from homeowners' ability to prepay. Policies addressing inflation and student debt could widen the wealth gap and have unintended consequences. Supply side concerns include potential price hikes and ongoing supply chain disruptions.
Investors with short volatility positions, particularly those with exposure to mortgage-backed securities, are effectively shorting ball (interest rate risk) due to homeowners' option to prepay. Meanwhile, policies aimed at combating inflation and forgiving student debt, while well-intentioned, could widen the wealth gap and have unintended consequences. On the supply side, concerns include potential price hikes in industries benefiting from debt forgiveness and ongoing supply chain disruptions. It's crucial for investors to stay informed about these developments and adapt their strategies accordingly.
Uncertain economic environment: labor market, supply chains, potential inflation: Stay diversified, uncertain correlation between stocks and bonds, inverted yield curve, negative convexity, stay informed, adaptable
The current economic environment is uncertain, with a tight labor market, chaotic supply chains, and potential for inflation. While some experts have raised the possibility of a supply side recession or stagflation, it's important for investors to stay diversified and not bet on any specific outcome. The correlation between stocks and bonds, which have been selling off together, is also unclear and could change. When looking at indicators, the inverted yield curve is particularly noteworthy, as it means short-term bonds are yielding more than long-term bonds, which is unusual. This inversion doesn't necessarily reflect the Fed's policy mistakes or an expected slowdown in growth, but rather the market's current perception. Negative convexity, which is a property of bonds that causes their price to decrease at an accelerating rate when interest rates rise, is also important to understand in this context. The implications of negative convexity for bondholders are that they could experience larger losses if interest rates continue to rise. Overall, it's crucial for investors to stay informed and adaptable in this uncertain economic climate.
Consider adding positively convexed fixed income exposures to hedge against interest rate volatility and inflation: Investors should consider adding positively convexed fixed income instruments, like long options, to their portfolios for potential exponential gains amidst high inflation and rising interest rates, offsetting potential losses from negative convexity in bond portfolios due to mortgage risk.
Investors should consider adding positively convexed fixed income exposures to their portfolios as a hedge against potential interest rate volatility and inflation. The interest rate market, which is larger than the US stock market, is an important but often overlooked market where investors can access these types of exposures. Most investors have negative convexity in their bond portfolios due to mortgage risk, making them vulnerable to increasing volatility and potential losses as quantitative tightening continues. Positively convexed instruments, such as long options, offer the potential for exponential gains when the underlying asset moves in favor of the investor. The current environment of high inflation and rising interest rates makes this an especially relevant consideration. While some may view tips as outdated, they can still offer valuable insights and opportunities in today's market.
Understanding the risks and limitations of inflation-protected bonds: Consider augmenting passive strategies with other inflation-protected instruments, TIPS have limitations and risks, passive ETFs may not offer protection, and understanding volatility markets is crucial
Retail investors should understand the limitations and risks associated with different types of inflation-protected bonds, such as Treasury Inflation Protected Securities (TIPS), and consider augmenting their passive investment strategies with other instruments that offer inflation protection. TIPS are relatively new instruments that reset with the level of consumer price index (CPI), and while they can provide protection against inflation, they are not included in most fixed income benchmarks like the AG index. Passive ETFs, which are popular among investors, may not offer inflation protection and can have correlations that are uncorrelated to equities or other indices. Volatility markets, which are important to understand when discussing inflation-protected securities, are essentially options markets that use volatility to price options. It's crucial for investors to understand what they own in their portfolios and to consider their personal risks when choosing investment strategies.
Understanding Volatility and Profiting from it with Public.com's 5.1% APY as a Side Hustle: Public.com offers a high-yield cash account, but NerdWallet's experts help find smarter financial products, including strategies to profit from volatility through long options positions and considering neutralizing short volatility exposure in bond portfolios.
Public.com offers a high yield cash account with an impressive 5.1% APY, which is higher than many other popular financial institutions. This is a paid endorsement for Public Investing. However, the financial world extends beyond cash accounts, and when it comes to making smart financial decisions, it's crucial to trust reliable sources like NerdWallet. NerdWallet's team of experts helps individuals find smarter financial products, enabling them to maximize their earnings, such as travel rewards. In the world of investments, volatility is often perceived negatively, but Trey Lockerbie discussed strategies that can profit from volatility. Long volatility strategies involve owning options, which can generate profits when volatility increases. Most investors may be unknowingly short on fixed income volatility in their bond portfolios. By understanding this, investors can consider neutralizing their short volatility exposure without taking a bet on fixed income volatility falling. Andrea Morby, a seasoned trader, shared her career journey, starting at Goldman Sachs during the late '90s when the US Treasury introduced Treasury Inflation-Protected Securities (TIPS). She recognized the limitations of using TIPS to hedge inflation and pivoted her career into the ETF business to address this issue and educate investors.
Considering assets with positive convexity for inflation protection: Investors should diversify portfolios with assets offering protection against inflation, such as long-term fixed income volatility and inflation-protected securities, while being aware of historical correlations and potential risks in a stagflationary environment. Retirees and those with higher fixed income allocations may need alternative hedges.
Traditional investment strategies, such as short duration bonds, may not provide the expected protection during periods of high inflation and economic uncertainty. Instead, investors should consider diversifying their portfolios with assets that offer positive convexity and protection against inflation, such as long-term fixed income volatility and inflation-protected securities. The speakers also emphasized the importance of being aware of historical correlations between asset classes and the potential risks of a stagflationary environment, where both stocks and bonds may sell off together. While commodities and real estate can be considered as potential hedges against inflation, investors should not rely solely on these assets and instead consider a well-diversified portfolio. Additionally, retirees and those with a higher allocation to fixed income may be particularly vulnerable to inflation risks and should consider alternative inflation hedges. The speakers also touched upon the evolving nature of inflation markets and the importance of staying informed about market trends and developments.
Investing in oil and energy stocks for inflation protection might not be enough: Consider alternative strategies like focusing on interest rates and fixed income for long-term inflation hedging. Ival's approach offers a consistent monthly payment since July 2019.
While oil and energy stocks have been strong investments in recent years due to underinvestment and geopolitical tensions, they may not be the only way to protect against inflation in the long term. Commodities, including oil, may not provide adequate inflation protection, especially as infrastructure improves and supply increases. Instead, investors may want to consider alternative strategies like Ival's approach, which focuses on interest rates and fixed income to hedge against inflation. Additionally, Ival offers a unique distribution model, providing investors with a consistent monthly payment since July 2019. This makes it an attractive option for investors looking to diversify their portfolios and protect against inflation beyond just commodities and energy stocks.
Emphasizing Interest Rate Spread Risk in Bond Portfolios: Investors should focus on interest rate spread risk in bond portfolios, as ETFs like IVAL's Eyeball Fund use options on Treasuries to profit from this risk. All bonds are long duration and will lose value when interest rates rise, so consider alternative strategies.
While many investors focus on corporate credit spread risk in bond portfolios, Nancy Davis of IVAL Advisors emphasizes the importance of interest rate spread risk. She explained that ETFs like her Eyeball Fund focus on this type of risk by using options on Treasuries, which profit from the spread between short and long-dated yields. Davis also noted that all bonds are long duration and will lose value when interest rates rise. She encouraged investors to understand this and consider alternative strategies like IVAL's. Additionally, Davis shared that TIP ETFs, which track inflation-protected Treasuries, had no monthly distributions in most cases in 2020 due to their variable yield nature tied to the consumer price index. Davis can be followed on Twitter @nancydouble\_davis, and more information about IVAL and the Eyeball Fund can be found on their website, ivaletf.com.
