By most accounts, the U.S economy is set to boom this summer: pent-up pandemic savings are burning a hole in consumers’ pockets, vaccines are rolling out and trillions of dollars in federal stimulus spending are working their way through the economy—not to mention the warmer weather ahead.
But the picture isn’t all rosy: some are worried the recovery might actually be too hot and prompt runaway inflation that erodes purchasing power and hurts households’ bottom lines.
Consumer price data for March painted a confusing picture—prices surged 2.6% on a year-over-year basis, partially because prices dropped to such low levels at the onset of the pandemic. But they also rose 0.6% between February and March—their largest monthly gain since August 2012. Experts, including Federal Reserve chair Jerome Powell and Biden Administration economists, have repeatedly said they expect a short-term bump in inflation as the economy recovers. They’ve emphasized that they expect this spike to be transitory and abate after conditions return to normal.
Consumers might not share that attitude: in a recent poll by CivicScience, 87% of American adults said they were “very” or “somewhat” concerned about rising costs of household expenses. And some are changing their spending habits already, with 27% of people reporting that they had been buying less because prices are higher.
Threat of dangerous inflation or no, those consumers are right about one thing. The pandemic has already had a major impact on prices—and it’s not all about stimulus money. Supply chain disruptions, changes to pre-pandemic supply and demand patterns and businesses eager to capitalize on the recovery boom all have the potential to drive prices up, and the shift is already happening.
Here are seven things you can expect to pay more for as the economy recovers—plus three things that will cost you less.
Wine, beer and liquor
Alcohol prices—including wine, beer and spirits—rose 2% in the year ended February 2021, according to data from the U.S. Bureau of Economic Analysis. Restaurant sales of alcohol plummeted during the pandemic, but online sales soared. A January report from Silicon Valley Bank predicted that wine sales and consumption will continue their upward trend in 2021 as the economy reopens, but noted the boost “may not be sustainable” after 2022.
A used car
A combination of pandemic-driven changes on the consumer front—moves to the suburbs, working from home, stimulus checks and excess savings—and a shortage of new cars thanks to supply chain issues and pandemic production slowdowns have sent prices for pre-owned cars soaring. Wholesale used car prices jumped an eye-watering 26% in March on a year-over-year basis, according to Cox Automotive.
Tampons, diapers and toilet paper
Consumer giant Procter & Gamble announced last week that it plans to hike prices on a variety of products in its baby care, feminine care and adult incontinence products this fall because of rising commodity costs. Mainstream baby care brands Luvs and Pampers are manufactured by Procter & Gamble, as are feminine care brands Always and Tampax.
P&G followed rival Kimberly-Clark, which has said it will hike its own prices in June for the same reason. Kimberly-Clark makes Huggies, Pull-Ups, Cottonelle and Scott toilet paper.
Home gardening supplies
Revamping your yard this year could be a little more costly than in years past thanks to a huge boom in home gardening during the pandemic. A survey conducted by the Freedonia Group in August found that 26% of adults had taken up food gardening during the pandemic—a trend that has also created shortages of certain types of seeds, NPR reported.
The price of seeds, flowers and potted plants surged more than 10.5% between February 2020 and February 2021, according to BEA data.
Your next DIY construction project
Lumber prices are soaring this spring and have nearly tripled since early 2020. That’s thanks in part to a home-building surge in the United States: 1.7 million new housing units were built in March alone—the highest monthly total since 2006. It’s also due to delays in a supply chain now stretched to the breaking point by both increased consumer demand and a pine beetle infestation in Canadian forests.
But prices might not stay this high for much longer: “Even though we expect lumber demand to hold up well for some time, we still think that a rebound in supply will lead to a sharp fall in the price of U.S. lumber over the next eighteen months,” Capital Economics analyst Samuel Burman wrote in a note reported by Bloomberg.
A new refrigerator
According to the Bureau of Economic analysis, major household appliance prices rose more than 12% in the year ended February 2021. That’s again thanks to a surge in demand—consumers are spending more time at home and either upgrading their existing appliances or replacing them as they break—and supply shortages caused by factory shutdowns in the early days of the pandemic.
A house
As the pandemic upends routines, demand for homes is also skyrocketing. Freddie Mac estimated this month that the housing shortage at the end of 2020 had risen to 3.8 million units, up from 2.5 million units in 2018. The National Association of Realtors said Thursday that the median price of an existing home was up 17.2% on an annual basis to $329,100 in March. Properties were only on the market for about 18 days in March before they were sold, NAR reported—a historic low.
A new wardrobe
Clothing and shoe prices went down 4.6% between February 2020 and February 2021, according to the BEA, as demand plummeted and consumers turned to work-from-home-friendly loungewear. But that lull might be over soon, especially as retailers look ahead to the reopening boom.
“Obviously, COVID-related stay-at-home mandates impacted customer buying behavior,” Urban Outfitters CEO Richard Hayne said last month. “We believe as vaccines become more widely distributed, new COVID cases continue to fall and government restrictions begin to loosen…apparel demand will accelerate.”
A loan
Interest rates are still at rock bottom and likely to remain there—at least for now. That means it’s a great time to borrow, especially if you have good credit.
Electronics and computer equipment
Prices for TVs and other electronics have been falling for years, and the pandemic was no exception. The price of audio-visual equipment went down 3.8% during the year ended February 2021, according to the BEA, while computer software prices dropped almost 8%. The price of calculators and other information processing equipment plummeted more than 16%.
I’m a breaking news reporter for Forbes focusing on economic policy and capital markets. I completed my master’s degree in business and economic reporting at New York University. Before becoming a journalist, I worked as a paralegal specializing in corporate compliance
[…] progress in political and policy domains in last few years, fifty million are malnourished, inflation and food insecurity driving individuals and groups into poverty […]
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[…] has witnessed a collapse in the price of crude oil, volatile movement in the exchange rate, rising inflation and food prices, dwindling Foreign Direct Investment, increasing unemployment, reduced public confidence in […]
[…] alone “are experiencing high levels of food insecurity through September due to economic decline, inflation and food price hikes exacerbated by the impacts of the COVID-19 pandemic” […]
[…] Inflation expectations (both for three months and one year) are influenced by realised inflation and food inflation in the post-inflation targeting period as compared to the pre-inflation targeting period […]
[…] alone “are experiencing high levels of food insecurity through September due to economic decline, inflation and food price hikes exacerbated by the impacts of the COVID-19 pandemic” […]
[…] alone “are experiencing high levels of food insecurity through September due to economic decline, inflation and food price hikes exacerbated by the impacts of the COVID-19 pandemic” […]
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[…] With the “double whammy” of social assistance lagging inflation and food prices outpacing it, single social assistance recipients “simply can’t afford” a reasonable diet […]
[…] results of Naval Battles, but through Pollard’s journal we are also able to track the effects of inflation and food shortages on France at this time […]
[…] Khartoum are experiencing high levels of food insecurity through September due to economic decline, inflation and food price hikes exacerbated by the impacts of the COVID-19 pandemic […]
[…] But a threat to food security that can cause inflation and food crises amidst the COVID19 pandemic has lifted its head! Foods for millions of people is vanishin […]
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[…] republic had replaced the old monarchy, and there were strikes, crime, corruption, bomb-throwing, inflation and food shortages together with the added complication of the First World War […]
[…] a debate in the Rajya Sabha on the General budget, Ms Sitharaman said as a against a double digit inflation and food inflation during the previous UPA Government, the NDA Government has managed to keep inflation well […]
[…] Getting to the real numbers of the Chinese economy is always a guessing game, but with inflation and food prices rising China’s market for automobiles has heavily contracted over the past year-and-a-half […]
[…] government over the years resorted to price controls and money printing to tackle skyrocketing inflation and food shortages, but the measures impoverished local state-owned agricultural companies and contribute […]
[…] government over the years resorted to price controls and money printing to tackle skyrocketing inflation and food shortages, but the measures impoverished local state-owned agricultural companies and contribute […]
[…] government over the years resorted to price controls and money printing to tackle skyrocketing inflation and food shortages, but the measures impoverished local state-owned agricultural companies and contribute […]
[…] government over the years resorted to price controls and money printing to tackle skyrocketing inflation and food shortages, but the measures impoverished local state-owned agricultural companies and contribute […]
[…] The women of Paris who bore the brunt of rising inflation and food shortages, and who were awakened to political life, led a march on Versailles, shaming thei […]
The new coronavirus Covid-19 will end up being the final curtain on China’s nearly 30 year role as the world’s leading manufacturer.
“Using China as a hub…that model died this week, I think,” says Vladimir Signorelli, head of Bretton Woods Research, a macro investment research firm.
China’s economy is getting hit much harder by the coronavirus outbreak than markets currently recognize. Wall Street appeared to be the last to realize this last week. The S&P 500 fell over 8%, the worst performing market of all the big coronavirus infected nations. Even Italy, which has over a thousand cases now, did better last week than the U.S.
China On Hold
On January 23, Beijing ordered the extension of the Lunar New Year holiday, postponing a return to work. The coronavirus was spreading fast in the epicenter province of Hubei and the last thing China wanted was for that to be repeated elsewhere. Travel restrictions and quarantines of nearly 60 million people drove business activity to a standstill.
The most frightening aspect of this crisis is not the short-term economic damage it is causing, but the potential long-lasting disruption to supply chains, Shehzad H. Qazi, the managing director of China Beige Book, wrote in Barron’s on Friday.
Chinese auto manufacturers and chemical plants have reported more closures than other sectors, Qazi wrote. IT workers have not returned to most firms as of last week. Shipping and logistics companies have reported higher closure rates than the national average. “The ripple effects of this severe disruption will be felt through the global auto parts, electronics, and pharmaceutical supply chains for months to come,” he wrote.
Workers in uniforms at a LED lighting factory in Dongguan, China. Around 70% of the world’s LED … [+]
Getty
That China is losing its prowess as the only game in town for whatever widget one wants to make was already under way. It was moving at a panda bear’s pace, though, and mostly because companies were doing what they always do – search the world with the lowest costs of production. Maybe that meant labor costs. Maybe it meant regulations of some kind or another. They were already doing that as China moves up the ladder in terms of wages and environmental regulations.
Under President Trump, that slow moving panda moved a little faster. Companies didn’t like the uncertainty of tariffs. They sourced elsewhere. Their China partners moved to Vietnam, Bangladesh and throughout southeast Asia.
Enter the mysterious coronavirus, believed to have come from a species of bat in Wuhan, and anyone who wanted to wait out Trump is now forced to reconsider their decade long dependence on China.
Retail pharmacies in parts of Europe reported that couldn’t get surgical masks because they’re all made in China. Can’t Albania make these things for you? Seems their labor costs are even lower than China’s, and they are closer.
The coronavirus is China’s swan song. There is no way it can be the low-cost, world manufacturer anymore. Those days are coming to an end. If Trump wins re-election, it will only speed up this process as companies will fear what happens if the phase two trade deal fails.
Picking a new country, or countries, is not easy. No country has the logistic set up like China has. Few big countries have the tax rates that China has. Brazil surely doesn’t. India does. But it has terrible logistics.
Then came the newly signed U.S. Mexico Canada Agreement, signed by Trump into law last year. Mexico is the biggest beneficiary.
It’s Mexico’s Turn?
Hecho en Mexico. Porque no?
Getty
Yes. It is Mexico’s turn.
Mexico and the U.S. get a long. They are neighbors. Their president Andres Manuel Lopez Obrador wants to oversee a blue collar boom in his country. Trump would like to see that too, especially if it means less Central Americans coming into the U.S. and depressing wages for American blue collar workers.
According to 160 executives who participated in Foley & Lardner LLP’s 2020 International Trade and Trends in Mexico survey, released on February 25, respondents from the manufacturing, automotive and technology sectors said they intended to move business to Mexico from other countries – and they plan on doing so within the next one to five years.
“Our survey shows that a large majority of executives are moving or have moved portions of their operations from another country to Mexico,” says Christopher Swift, Foley partner and litigator in the firm’s Government Enforcement Defense & Investigations Practice.
Swift says the move is due to the trade war and the passing of the USMCA.
The phase one China trade deal is a positive, but the coronavirus – while likely temporary — shows how an over-reliance on China is bad for business.
There will be fallout, likely in the form of foreign direct investment being redirected south of the Rio Grande.
“Our estimates of possible FDI to be redirected to Mexico from the U.S., China and Europe range from $12 billion to $19 billion a year,” says Sebastian Miralles, managing partner at Tempest Capital in Mexico City.
“After a ramp-up period, the multiplier effect of manufacturing FDI on GDP could lead Mexico to grow at a rate of 4.7% per year,” he says.
Trump arrives to speak about the United States – Mexico – Canada agreement, known as USMCA, during a … [+]
AFP via Getty Images
Mexico is the best positioned to take advantage of the long term geopolitical rift between the U.S. and China. It is the only low cost border country with a free trade deal with the United States, so there you have it.
Thanks to over 25 years of Nafta, Mexico has become a top exporter and producer of trucks, cars, electronics, televisions, and computers. Shipping a container from Mexico to New York takes five days. It takes 40 days from Shanghai.
They manufacture complex items like airplane engines and micro semiconductors. Mexico is the rank the 8th country in terms of engineering degrees.
Multinational companies are all there. General Electric is there. Boeing is there. Kia is there.
The trade war is yet to be decided, but the damage that has already been done will not be undone. Room for a new key commercial ally is open.
A worker at Canada’s Bombardier factory in Mexico. (Photo by Carlos Tischler/SOPA Images/LightRocket … [+]
LightRocket via Getty Images
Safety remains a top issue for foreign businesses in Mexico who have to worry about kidnappings, drug cartels, and personal protection rackets. If Mexico was half as safe as China, it would be a boon for the economy. If it was as safe, Mexico would be the best country in Latin America.
“The repercussions of the trade war are already being felt in Mexico,” says Miralles.
Mexico replaced China as the U.S. leading trading partner. China overtook Mexico only for a short while.
According to Foley’s 19 page survey report, more than half of the companies that responded have manufacturing outside of the U.S. and 80% who do make in Mexico also have manufacturing elsewhere. Forty-one percent of those operating in Mexico are also in China.
When respondents were asked about whether global trade tensions were causing them to move operations from another country to Mexico, two-thirds said they already had or were planning to do so within a few years. A quarter of those surveyed had already moved operations from another country to Mexico on account of the trade war.
For those considering moving operations, 80% said they will do so within the next two years. They are “doubling down on Mexico”, according to Foley’s report.
Of the companies that recently moved their supply chain, or are planning to do so, some 64% of them said they are moving it to Mexico.
I’ve spent 20 years as a reporter for the best in the business, including as a Brazil-based staffer for WSJ. Since 2011, I focus on business and investing in the big emerging markets exclusively for Forbes. My work has appeared in The Boston Globe, The Nation, Salon and USA Today. Occasional BBC guest. Former holder of the FINRA Series 7 and 66. Doesn’t follow the herd.
With The market already down more than 10%, the coronavirus-triggered plunge may turn into one of the fastest bear markets to hit U.S. stocks ever. But, believe it or not, a passive investment in the S&P 500 may be the best way to ride out and ultimately profit from the storm.
The global contagion is slowing international travel. Oil is plunging as traders anticipate falling demand for jet fuel from airlines. Energy stocks like ExxonMobil are trading at lows not seen since the 2008 crisis. Stocks of brick and mortar retailers, malls, movie theaters, cruise ship operators, amusement parks and airlines are also plummeting as investors forecast people hunkering down at home.
As coronavirus spreads, the problems at these companies will worsen and cyclical sectors that track closely with global gross domestic product growth will also suffer. This morning, the industrial and materials sectors went into the red, posting negative returns for the past 12 months. They joined energy, down 30% over the year, as the only sectors to lose money. The S&P 500 is still ahead 7% year-over-year.
Here’s the good news: Your index fund already predicted all of this.
Even before the coronavirus became a global crisis, the S&P 500 was under-weighted in the types of stocks that were most vulnerable to the outbreak and it was heavily over-weighted in the software, internet, online retail and social media companies that are likely to either weather the storm, or thrive.
The Coronavirus Plunge
Coronavirus caused the quickest 10% market correction since the 2008 financial crisis.
Almost a quarter of the S&P 500 index is comprised of the ten biggest companies in America by market capitalization: Microsoft, Apple, Amazon, Facebook, Berkshire Hathaway, Alphabet (Google), JPMorgan Chase, Johnson & Johnson, Visa and Wal-Mart.
These companies have pristine balance sheets and strong long-term growth prospects to manage through the outbreak. Some may also see increased sales as people stockpile food and health safety products, or benefit from people staying at home. About half of the overall S&P 500 is in information technology, healthcare and communications stocks —all unlikely to see major long-term disruptions due to the outbreak.
On the other hand, the types of businesses that are in free-fall, such as energy and retail, hardly make a dent as a weighting in the S&P 500. For instance, the entire energy sector entered 2020 at about the same weight as Apple alone. Thus energy’s 20% plunge over the past month is causing relatively minor pain. Retailers like Macy’s, Gap and Nordstrom that may struggle further are also minor weightings, in addition to small-sized drillers like Cimarex Energy, Helmerich & Payne, Cabot Oil & Gas and Devon Energy.
While holders of the S&P have sidestepped the worst stock implosions since the outbreak, they’re also big holders of potential beneficiaries.
Johnson & Johnson, United Health Group and Procter & Gamble are about 1% index weightings and they could see an uptick in sales as people all the world prepare for the virus’s spread. If more people begin to work from home, companies like Microsoft will benefit as demand spikes for its suite of cloud products including email and remote working services. Wireless carriers like Verizon and cell tower giants SBA Communications and American Tower will benefit from rising smartphone and internet activity.
Any surge in online sales will help ecommerce companies like Amazon and logistics warehouse operator Prologis as well as another S&P 500 member Equinix, one of the largest data center real estate investment trusts. Streaming services like Netflix and internet giants like Google and Facebook will also see a boost in eyeballs from masses of homebound Americans.
You guessed it. Each of these companies has high weightings in the S&P 500.
Your Index Fund Picks Winners
The biggest weights in the S&P 500 are also the largest and most successful companies in America.
The index is well-prepared for the coronavirus because it is designed to track changes in the economy, which may actually be accelerated by the outbreak. The S&P 500 weights companies by market capitalization, meaning it increases exposure to companies with improving business prospects and rising stock prices, and it decreases exposures to those with worsening fates.
Already, people have been avoiding department stores and brick and mortar retailers, and driving more efficient vehicles, cutting back on oil and gas consumption. Movie theaters are being made obsolete by streaming media services. By design, the S&P has done a near-perfect job keeping up with these changing economic trends and consumer habits.
Investors, meanwhile, have spent the past decade bidding up the stock values of cash-generating software and internet companies, and have been abandoning stocks in companies with heavy debts and large pension obligations, or those exposed to economic cycles. Here again, the S&P 500’s algorithm has been trimming holdings in burdensome industrial companies and auto manufacturers. Information technology, the most heavily weighted in the index has fallen about 5% over the past month, but is still up 23%-plus over the past year.
In 2007, at the outset of the financial crisis, Berkshire Hathaway’s Warren Buffett famously predicted an ordinary investor in an S&P 500 index fund would beat just about any hedge fund on Wall Street. Buffett offered a $1 million bet—payable to charity—to anyone who thought they could pick hedge funds that would beat the index over the ensuing decade.
A hedge fund investor named Ted Seides took up Buffett’s wager. It wasn’t even close. Seides conceded a loss in 2015, waving a white flag of defeat before the decade was over. The S&P returned 8.5% annually over that ten-year stretch, while the average hedge fund failed to deliver half that return.
The reality is as follows: Market corrections like the current one are frightening. But sometimes, the smartest play is also the easiest. With an investment in the S&P 500, the house is on your side.
I’m a staff writer at Forbes, where I cover finance and investing. My beat includes hedge funds, private equity, fintech, mutual funds, M&A and banks. I’m a graduate of Middlebury College and the Columbia University Graduate School of Journalism, and I’ve worked at TheStreet and Businessweek. Before becoming a financial scribe, I was a part of the fateful 2008 analyst class at Lehman Brothers. Email thoughts and tips to agara@forbes.com. Follow me on Twitter at @antoinegara
As recent numbers show, the Netherlands ranks very high in international rankings on innovation and competitiveness. It ranks fourth in the 2019 editions of both the Global Innovation Index and the Global Competitiveness Index, making it Europe’s most competitive economy. At the same time, its energy usage is least sustainable of all countries in Europe and its air is one of most polluted in Europe too. What is going on? Do we have a new “Dutch Disease?”
The old Dutch Disease
The term “Dutch Disease” was coined by The Economist in 1977. As they explain in a 2014 article, it refers to a situation in which discoveries of large amounts of natural resources could be harmful to the economy in the long-term. At that time, it referred to the discovery of significant amounts of natural gas in the Dutch part of the North Sea and a resulting economic decline.
There are at least three explanations for this paradoxical economic decline. First, it results from changes in currency exchange rates following a large inflow of foreign currency, leading to a worse competitive position, reduced export and increased unemployment. Second, the discovery of significant natural resources can disturb the national economy. The income generated with the natural resources can lead to an increased demand for luxury goods and services, triggering workers to go there and leave other sectors like manufacturing. Third, the discovery of natural resources also can trigger governments to overspend on social security and other public means, which are counterproductive and untenable in the long run (see also this article for a good explanation of the original Dutch Disease).
A New Dutch Disease?
The current situation in the Netherlands is obviously very different than in 1977. There are no new discoveries of natural resources and there is no economic decline. On the contrary, as the rankings referred to above indicate, the Dutch economy is doing very well. And with respect to natural resources: due to increasing earth quakes caused by the extraction of natural gas, the Dutch usable gas reserve actually quickly decreases as well as the political and public support for further extraction.
But nevertheless, the extreme opposing rankings in terms of economy (top) and sustainability (bottom) are indicating something is going on in the Netherlands that is not quite right. Hence, the question: is there a New Dutch Disease?
On the surface there are two simple explanations for the contrasting rankings. The first is that the high rankings on innovation and competition are a direct result of efficient use of available natural resources rather than spending expensive money on alternative energies and clean air. Seen as such, it is simply old school smart business. The second explanation is that every Euro can only be spent once: either in the economy or elsewhere, such as in reducing a country’s climate impact. Seen from that perspective, it is not more than logical that the Netherlands’ high scores on economy are accompanied by low scores on sustainability—they simply reflect the priorities set by the Dutch government.
But such trade-off thinking is too simple. It suggests improved sustainability and economic prosperity are opposite goals and cannot be improved at the same time. Countries like Sweden and Finland show this is just not true. These countries rank 2nd and 6th in the Global Innovation Index, 8th and 11th in the Global Competitiveness Index and 1st and 2nd in Europe in terms of use of renewable energy. This means that the two can go hand in hand very well indeed.
A third simple explanation of why this is not possible in the Netherlands can be given. It is a small and densely populated country, making it much harder than Sweden and Finland to use alternative sources of energy and keep the air clean—there simply is too little space for solar panels and windmills and with more people and cars per square kilometer, the air gets polluted quicker.
Like the first two explanations above, there is of course an element of truth in this third explanation too. Yet, it is not entirely convincing and together they don’t explain well enough what is going on. There is one important—mental—element missing: comfort, or lack of willingness to change.
From an economic point of view, the situation in the Netherlands is comfortable. The economy is doing well, all resources that are needed are available or can be bought elsewhere and there is no direct danger or urgency requiring change. This has made my country, in Pink Floyd’s terms “comfortably numb.” You can also call it lazy.
In this sense, this “new” Dutch Disease is not so different from the “old” Dutch Disease. Even though the mechanisms for economic decline in the Dutch Disease work via currency exchange rates, export, shifts in employment between sectors and so on, the real issue in the 1970s was the same as today: because of a short-term comfortable position, choices are made that harm the country on the long-term.
Being Dutch and living in the Netherlands, I prefer to be proud of my country. Along those lines, I’ve written about beautiful companies such as Coolblue, Tony’s Chocolonely, Fairphone and KLM. However, in this case I feel embarrassed to be Dutch. Especially about living in the country with the lowest share of renewable energy in Europe. With such great innovation power and such great competitive position, it should be easy to climb up the sustainability ladder in a fast pace. So, it is time to get out of the comfort zone. Or, I would almost say, let’s make the Netherlands great again.
I am a strategy consultant, trainer, writer and speaker. As strategy professor and consultant I help leaders and organizations across the globe deal with the strategic challenges they face in an uncertain, complex, and fast-changing world. My drive is to bring strategy to the next level with new and effective approaches and tools. Along that line, I wrote the two-volume “The Strategy Handbook”—a practical and refreshing guide for making strategy work and “No More Bananas”—a nine-step approach for keeping your cool in today’s madness. You can reach out to me via jeroenkraaijenbrink.com, LinkedIn or jk@kraaijenbrink.com.
Stocks have recovered from last fall’s crash, low interest rates stretch out to the horizon and the VIX volatility index is half what it was at Christmas. Sit back and coast to a comfortable retirement.
No, don’t, says Nancy Davis. This veteran derivatives trader runs Quadratic Capital Management, where her somewhat contrarian view is that investors, all too complacent, are in particular need of insurance against financial trouble.
The Quadratic Interest Rate Volatility & Inflation Hedge ETF, ticker IVOL, is designed to provide shelter from both inflation and recession. Its actively managed portfolio mixes inflation-protected Treasury bonds with bets, in the form of call options, on the steepness of the yield curve.
Those options are cheap, for two reasons. One is that, at the moment, there is no steepness: Yields on ten-year bonds are scarcely higher than yields on two-year bonds. The other is that the bond market is strangely quiet. Low volatility makes for low option prices.
“Volatility has been squashed by central bank money printing,” Davis says, before delving deep into the thicket of option mathematics. If volatility in interest rates rebounds to a normal level, her calls will become more valuable. Alternatively, she would get a payoff if the yield curve tilts upward, which it has a habit of doing when inflation surges, stocks crash or real estate is weak.
If IVOL is all about peace of mind for the investor, it’s all about risk for its inventor. Davis, 43, has poured her heart, soul and net worth into Quadratic, of which she is the founder and 60% owner. If the three-month-old exchange-traded fund takes off, she could become wealthy. If it doesn’t, Quadratic will struggle.
The fund showed its worth in the first week of August, climbing 2% as the stock market sank 3%. But it needs a much bigger shock to stock or bond prices in order to get big. It has gathered only $58 million so far. A crash had better arrive soon; IVOL’s call options expire next summer. Quadratic, moreover, needs to somehow scale up without inspiring knockoff products from ETF giants like BlackRock.
Davis was a precocious trader. As an undergraduate at George Washington University, she took grad courses in financial markets while earning money doing economic research for a consulting firm. She put some of her paychecks into a brokerage account. “Some women love to buy shoes,” she says. “I love to buy options.”
This was in the 1990s, a good time to indulge a taste for calls. Davis made out-of-the-money bets on technology stocks, which paid off well enough to cover the down payment, in 1999, on a New York City apartment. Nice timing.
There may be a sour grape, but there’s also truth in her current philosophy that hedge funds are not such a great deal for investors. ETFs, she says, are more liquid, more transparent and cheaper.
Davis spent a decade at Goldman Sachs, most of it on the firm’s proprietary trading desk, then did a stint at a hedge fund. At 31 she quit to actively manage two kids. Returning to Wall Street after a three-year hiatus, she worked for AllianceBernstein and then did what few women do, especially women with children: She started a hedge fund.
Quadratic, whose assets once topped $400 million, used a hedge fund platform at Cowen & Co. When Cowen ended the partnership last year, Davis set about reinventing her firm. There may be a sour grape, but there’s also truth in her current philosophy that hedge funds are not such a great deal for investors. ETFs, she says, are more liquid, more transparent and cheaper.
IVOL’s 1% annual fee is stiff, but Davis says it’s justified for a fund that is not only actively managed but also invested in things that ordinary folk cannot buy. If you want to duplicate her position in the Constant Maturity Swap 2-10 call due July 17, you’d need to know what banker to ring for a quote, because this beast is not traded on any exchange. Each of these calls, recently worth $7.71, gives the holder the right to collect a dollar for every 0.01% beyond 0.37% in the spread between ten-year interest rates and two-year interest rates. The spread has to move a long way up before the option is even in the money. But at various times in the past the spread has hit 2%. Could it do that again? Maybe, at which point the option pays $163.
Starting a firm like Quadratic is like buying an out-of-the-money call: long odds, big payoff. Davis is doing what she was doing in college. You can’t stop a trader from trading.
I aim to help you save on taxes and money management costs. I graduated from Harvard in 1973, have been a journalist for 44 years, and was editor of Forbes magazine from 1999 to 2010. Tax law is a frequent subject in my articles. I have been an Enrolled Agent since 1979. Email me at williambaldwinfinance — at — gmail — dot — com.
Nancy Davis, founder and CIO of Quadratic Capital Management, introduces her new ETF that takes advantage of interest volatility and inflation expectations: IVOL. In this interview with Real Vision’s co-founder & CEO Raoul Pal, Davis deconstructs the structure of the ETF, highlights the cost of carry associated with the strategy, and discusses her macro outlook and where she thinks the yield curve is headed next. Filmed on May 29, 2019. Watch more Real Vision™ videos: http://po.st/RealVisionVideos Subscribe to Real Vision™ on YouTube: http://po.st/RealVisionSubscribe Watch more by starting your 14-day free trial here: https://rvtv.io/2KHDkoc About Trade Ideas: Top traders unveil their specific plans for cashing in on the market’s next move. In these short videos, our traders cut straight to the point and lay out their thoughts on the best risk-reward trades of the moment. Each episode concludes with a visual recap of trade details including profit-loss potential and trade duration. About Real Vision™: Real Vision™ is the destination for the world’s most successful investors to share their thoughts about what’s happening in today’s markets. Think: TED Talks for Finance. On Real Vision™ you get exclusive access to watch the most successful investors, hedge fund managers and traders who share their frank and in-depth investment insights with no agenda, hype or bias. Make smart investment decisions and grow your portfolio with original content brought to you by the biggest names in finance, who get to say what they really think on Real Vision™. Connect with Real Vision™ Online: Twitter: https://rvtv.io/2p5PrhJ Instagram: https://rvtv.io/2J7Ddlw Facebook: https://rvtv.io/2NNOlmu Linkedin: https://rvtv.io/2xbskqx The ETF Play on Interest Rate Volatility (w/ Nancy Davis) https://www.youtube.com/c/RealVisionT… Transcript: For the full transcript visit: https://rvtv.io/2KHDkoc NANCY DAVIS: So we invest with options with a directional bias on everything. So our new product that we recently launched, IVOL, is the first inflation expectations and interest rate volatility fund out there. It’s a exchange traded product. RAOUL PAL: Does anybody even know what that means? NANCY DAVIS: So what we do is for an investor, if you’re an equity investor, you want to have tail protection, for instance. It’s hard to own equity volatility as an asset allocation trade because it decays so aggressively. So it’s a more benign way to carry volatility as an asset class from the long side using fixed income vol. It’s not as sensitive as equity vol, but it’s a lot lower level. Like, the vol we’re buying is 2, 2 basis points a day in normal space. So it’s very, very cheap, in my opinion, and it gives you a way to have an asset allocation to the factor risk of volatility without having as much decay as you would in the equity space. And then for a fixed income investor, the big risk there is obviously Central Bank policy, fiscal spending, trade wars, as well as inflation expectations. And we saw a need to really give a fixed income investor a way to capitalize on the deflation that’s been priced into the market for the next decade. I mean, so current US inflation is around 2%. The five-year break-even is 1.59%. So that’s an opportunity in an option space. And so it’s long options with TIPS. And so that gives investors exposure. It gives you inflation-protected income, but also options that are sensitive to inflation expectations. And we think it’s pretty– you know, you’re never going to time these macro calls perfectly. But given the Central Bank in the US is so focused right now on increasing inflation expectations, and there’s been so much talk about the yield curve inverting– and that’s kind of crazy. If you step back and you’re like, all right, we have a $3.9 trillion balance sheet. We have a fiscal budget deficit. We have unclear or radically changing monetary policy. If you look where we are now with so many cuts priced into the interest rate markets in the US versus where we were four months ago, it’s wildly different. And at the same time, interest rate volatility is literally at generational lows. Equity, while people talk about equity vol, I think VIX today is 17. It’s low, I guess, in the context. But when you look at a percentile, like one-year vol over the last decade in equities, it’s about the 70th percentile. So it might be low, but it doesn’t mean it’s cheap. Interest rate volatility is literally at, like, 2, 1, you know, 0.