Bailout
Bailout
Welcome all new subscribers to Alpha Letter. Every week I write about interesting opportunities in the public market. I focus on stocks off the beaten path. Broken businesses. Assets trading under liquidation value. Macroeconomics and where the economy is heading. I don’t like investing in large, popular companies and find a fascination with assets no one else is looking at.
Today’s piece will be focused on the the Fed and why I think they will eventually lower interest rates to zero.
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Bailout
Markets are red across the board. It’s total bloodshed season. Nothing has been spared. Energy is getting blasted. Technology companies in freefall. Valuations have been halved. Every company I look at is showing a trailing P/E ratio in the 4.0x range. We are approaching 2020 lows for a lot of assets. The market implosion won’t end until the Fed pivots and lowers rates. Macroeconomic forecasts don’t matter 99% of the time as a bottoms up fundamental investor. But when they do matter that is all that matters.
Wednesday morning was a whirlwind. I woke up to news that the Bank of England would begin to buy bonds on whatever scale is needed to calm the economic storm. I did a double take. At first I thought it was a joke headline. Something The Onion would make up. I quickly realized it was not a joke. The Bank of England appeared to literally be buying bonds after raising rates to calm the market.
Stocks flew upward on Wednesday. Bond buying or quantitative easing is generally bullish for stocks. When a central bank purchase bonds on the open market it is an inflationary signal. Asset prices rise, yields falls and discount rates go to zero. The best place to be during an inflationary period is stocks. Buying bonds is a huge inflationary signal. Everyone wanted back in.
Thursday morning more news broke on the reversal in the Bank of England’s monetary decision. Panic at pension funds led the Bank of England to enact an emergency intervention. The plunge in bond prices was so sharp that some pension funds began to get margin called from their brokers. The Bank of England will continue to purchase bonds until October 14th in order for pension funds to manage and sell these assets to avoid default.
Markets crashed into Thursday on the idea that the Central Bank of England was not doing a total bailout to roll rates back to zero, but a small bailout to save pension funds. In addition Loretta Mester, the president and CEO of the Federal Reserve of Cleveland stated that a recession won’t stop the Fed from raising rates. This put U.S. investors into doubt about a potential quantitative easing program being established across the Western hemisphere.
We are in a weird part of the market cycle where inflation is roaring, unemployment is low and demand for everything is skyrocketing. Hyperinflation is the destroyer of societies and economies and policymakers will do everything in their power to stop it. Central bankers across the globe appear to have come to an agreement to raise rates and put the world into an economic recession. Their goals are to artificially slow demand by raising rates, causing unemployment and cooling inflation. Deflationary trends are already being seen as asset prices collapse and leading tech companies layoff employees.
The Fed only started raising rates to combat inflation when the American people started to get anxious and complain about higher prices. Inflationary policies went from a “do nothing” approach to raising rates and fighting back. My guess is the Fed will lower rates and combat a recession the moment individuals start complaining about their lost jobs and 401Ks eating dust. To retain political power you must appease the population. When people start looking at their diminishing 401Ks and lost jobs the policymakers will change course and lower rates. The game is to retain power.
There is also the dynamic of the $31 trillion of National debt. It becomes virtually impossible to service $31 trillion in debt at a 4-6% interest rate. The Fed is effectively increasing the annualized costs of the U.S. government by trillions per year through rate raises. Running a country with $31 trillion in debt on 4-6% rates become virtually impossible.
Eventually the Fed will pivot and lower rates to fight the gorilla in the room, the $31 trillion of National debt. The only way at this point to run a balanced budget is by inflating that debt away. When the Fed pivots and chooses the inevitable inflation, you will want to be in equities. Equities have historically been the best tool to hedge yourself against hyperinflation. Own businesses and real assets.
At the end of the day there is $31 trillion of debt. It is completely unsustainable to run a country with that much debt paying trillions in interest per year. The Fed will lower rates back to zero and equity valuations will soar as money is printed to the ceiling. The markets are still in charge and they will not tolerate quantitative tightening. Valuations are cheap and approaching 2020 lows. Buy real assets and think for the long-run. This is a historic opportunity to buy great companies at basement level valuations. Be patient and own real assets. Equities always win.
Potential Stock Idea
Hurricane Ian blew through Central Florida over the past few days and has strung up an opportunity of a company I have been interested in investing in for years. The stock price of this company has fallen from the highs of $45 per share to right at $30 this past year. Yesterday the stock plunged another 8% as fears over the hurricane likely will impact the core business and make for a weak 2023.
Revenues in 2023 might be down 30-50% depending on how bad the hurricane hit the areas of production. The stock could fall another 10-20%. I’d be very interested if that occurred and likely buy as much as I can.
The core business is ok, but the real investment thesis is predicated on the value of the underlying land that this company owns. This company owns over 80,000 acres of pristine land in Florida that continues to get more valuable every year. At the end of the day you are not purchasing an operating company that is getting impacted by a hurricane. You are purchasing pristine land that is trading meaningfully under the true replacement value. There is a huge margin of safety here and the cheaper the stock gets from a hurricane impact the more I get interested.
I’ve followed this company for years and have been waiting for an opportunity like this to make a position. I plan to continue to evaluate the situation and should have an investment write-up out for Alpha Letter Pro subscribers this weekend. If you want access to this write-up consider subscribing below and join an active group of investors who talk daily in a group chat. If you don’t like the value you get from Alpha Letter Pro you can unsubscribe anytime, no questions asked.
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So, the company is...?