Tap Dancing with TINA & a Moment to Remember in US Monetary Policy

Macro Investing: The Rising Pressure of a Decade of Fiscal Profligacy

KCR’s investment process does not use macro inputs or engage in macro trading.  We use historical security-level data around valuation, profitability, quality, and other metrics to identify opportunities for short sellers and long investors alike.  Macro investing can be a challenging endeavor.

A great example is the enormous bailout of Wall Street used to end the Great Financial Crisis.  Many people thought a brutal bout of inflation was inevitable.  Instead, the world proceeded to borrow and spend ever larger sums.  And the more governments borrowed and spent, the lower interest rates fell.

A piece by the always-wonderful John Authers explained how the recent tax cuts in the UK detonated a Lehman-like crisis in gilts.  His walk-through of the stunning -24% collapse and subsequent rally of the 30-year British bond was a terrific reminder of how the big picture doesn’t matter until it is all that matters.

This piece is not designed to wow macro investors or macro hedge funds. KCR was simply stunned at our own complacency on what is, ultimately, a very basic issue.  The world has gone from pillorying the Fed for keeping rates too low to screaming bloody murder for taking them to 3.25%.  In many ways, the agonies a meager 3.25% have caused global markets is a testament to the enormous leverage and fragility of our financial system.

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We also believe the very simple analysis below is at the heart of why the Fed must shatter inflation.

[i] The longest endnote ever: so here we are transitioning from the use of “net interest expense” to “gross interest expense.”  The CBO does a remarkable job explaining all this.  Yet we felt the CBO’s, and KCR’s, decision to move to a discussion of “gross interest expense” makes sense.   Here are some examples of why gross interest expense makes sense to KCR.

  • So, the “gross amount” is simply the total payments on the stock of debt outstanding. For the net figure the CBO and other agencies have to add back myriad and sundry receipts received from a wide array of sources.
  • FIRST: One primary example is the interest paid on the $5.9 trillion in Treasury securities held by trust funds. These include things like Social Security and the pensions for military and other government workers.  As the CBO notes “However, the interest paid on those securities has no net effect on interest outlays because both the payments and the receipts are recorded in the same category of spending in the Federal budget.  The payments are part of gross interest paid on Treasury securities, and receipts appear separately in the net interest category.”  That sounds, to macro lay people like us, a bit like paying interest on an asset in a pension account, recording that payment to the pension account but then deducting it right back out due to technical accounting reasons of the affiliation of the payor and the payee.
  • SECOND: We find similar language later on when they explain that our government also gets money back from a category dubbed “other interest.” This add back is from interest received on “specialized financing accounts.”  The “…largest of those accounts finances the federal student loan programs.”   If you’re wondering if that might be an “add back” that’s about to go away, so are we.
  • THIRD: Another area that helps reduce “gross interest expense” to “net interest expense” is the government’s business in loan guarantees. As the CBO explains, “With [loan guarantees] the government agrees to repay, in the event of a default, loans made by nongovernmental institutions.  Financing accounts for guaranteed loan programs usually receive cash inflows when a loan is made, and the inflows often include guarantee fees from lenders and subsidy payment from the budget account for the loan program.  Any defaults on loans that would require a payment from the account typically occur later.  As a result, a financing account for a guarantee program generally runs a surplus, and it loans that surplus to the Treasury, which credits the financing account with interest payments.(Emphasis ours).  That sounds a bit like “we get to clip coupons and reduce the appearance of interest expense until things go bump in the night, in which case, suddenly we are on the hook.”   
  • FOURTH: The final example we will give, is the most important. Specifically, that the payments from the trust funds (Social Security, pensions etc.) will decline even in a rising rate environment.  Why?  Because “…payments to beneficiaries are projected to outweigh revenue collections in several of the largest funds, causing balances to decline faster than interest rates rise.  … balances in three trust funds are projected to be exhausted during [the forecast] period.”  (Emphasis ours).  Which trust funds exactly will run out of money?  The Highway Trust Fund, Medicare’s Hospital Insurance Trust Fund and Social Security’s Disability Insurance Trust Fund.

[ii] What is the National Debt, US Treasury

[iii] Gross Domestic Product and Corporate Profits, Q2 2022, BEA

[iv] US Treasury as of August 2022

[v] US Treasury as of August 2022

[vi] The government’s fiscal year is from October 1st – September 30th, so the most recent bar excludes the month of September 2022.

[vii] https://www.usaspending.gov/explorer/budget_function

[viii] Office of Debt Management, FY 2022 Q3, page 23

[ix] Office of Debt Management, FY 2022 Q3, page 26

[x] US Government Accountability Office, Report to Congress, May 2022.

[xi] From the fiscal data website provided by treasury.gov on “What is the national debt

  1. As a reminder for our Financial Advisors: our models are available on a continuous basis, and most have been in production for over a decade.  If you are looking for simple, concentrated, low turnover, and tax efficient model portfolios we would like to talk with you.  KCR also offers a wide range of easy-to-use but sophisticated tools.  Our toolkits can help identify mispriced stocks with the best and worst risk/reward characteristics, estimate a stock’s duration and warn you when a company is engaging in low-quality accounting. Over the last 12 years, KCR has built and offers time-tested and class-leading products built by experienced and proven money managers for fixed to low prices.
  2. Kailash Capital’s sister company, L2 Asset Management, runs market neutral, long/short, large-cap, and mid-cap long-only portfolios with a value and quality bias.  L2 employs a highly disciplined investment process characterized by moderate concentration, low turnover, high tax efficiency, and low fees. While nobody can predict the future, we believe the recent resurgence in risk-adjusted returns seen across all products is the beginning of what may be a long period where speculation is punished, and prudence and patience rewarded.
The topics discussed in this article are aimed at seasoned professionals, as such, we have included some extra for anyone seeking out more information related to the topics above.

Disclaimer

The information, data, analyses, and opinions presented herein (a) do not constitute investment advice, (b) are provided solely for informational purposes and therefore are not, individually or collectively, an offer to buy or sell a security, (c) are not warranted to be correct, complete or accurate, and (d) are subject to change without notice. Kailash Capital, LLC and its affiliates (collectively, “Kailash Capital”) shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information herein may not be reproduced or retransmitted in any manner without the prior written consent of Kailash Capital. In preparing the information, data, analyses, and opinions presented herein, Kailash Capital has obtained data, statistics, and information from sources it believes to be reliable. Kailash Capital, however, does not perform an audit or seeks independent verification of any of the data, statistics, and information it receives. Kailash Capital and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your tax, legal, and accounting advisors before engaging in any transaction. © 2021 Kailash Capital, LLC – All rights reserved.

Nothing herein shall limit or restrict the right of affiliates of Kailash Capital, LLC to perform investment management or advisory services for any other persons or entities. Furthermore, nothing herein shall limit or restrict affiliates of Kailash Capital, LLC from buying, selling or trading securities or other investments for their own accounts or for the accounts of their clients. Affiliates of Kailash Capital, LLC may at any time have, acquire, increase, decrease or dispose of the securities or other investments referenced in this publication. Kailash Capital, LLC shall have no obligation to recommend securities or investments in this publication as result of its affiliates’ investment activities for their own accounts or for the accounts of their clients.

October 7, 2022 |

Categories: Quick Takes

October 7, 2022

Categories: Quick Takes

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