above 5%... means, much more work for me...

Duration: 16:14 2062 transcript words EN summary

Video summary

The central theme of this discussion is the profound shift in global financial markets triggered by the US 10-year Treasury yield surpassing 5%, a level not seen since the mid-2000s and reminiscent of the high-interest environment of the 1990s. For decades, investors have been accustomed to declining interest rates that fueled asset price appreciation and made borrowing cheap, but this new reality introduces significant headwinds for equity valuations and real estate. The speaker argues that the risk-free rate now acts as a powerful anchor; when it rises, assets like LVMH stocks, UK home builders, and even dividend-paying giants like McDonald's become less attractive because their yields fail to compete with government bonds. This dynamic has already caused corrections in specific sectors, such as European real estate and US housing, where mortgage rates climbing toward 7% are dampening demand and squeezing growth potential. The transcript highlights the severe implications of this rate hike for corporate debt and government finances, using Google's long-term bonds as a stark example of how rising yields can instantly erode asset values. Bonds issued years ago at low coupon rates now trade at significant discounts, causing massive paper losses for holders who bought in 2020, while issuers like Google face drastically increased borrowing costs that will inevitably reduce future investment capacity. On a macroeconomic level, the speaker points out that the US government's deficit is unsustainable under these new conditions; if interest rates remain elevated on the current debt load, the annual interest cost could double from roughly one trillion to two trillion dollars. This creates a dangerous feedback loop where high borrowing costs crowd out other investments and stifle economic growth, challenging the political strategy of relying on GDP growth to pay down deficits without implementing painful fiscal cuts. Despite the uncertainty and the risk that AI-driven earnings might be overvalued or that an eventual recession could correct stock prices significantly, the speaker advises against trying to time the market or predict crashes with high certainty. Historical data shows that US markets have experienced massive real-term declines over decades, suggesting that a simple "buy and hold" strategy without hedging is no longer guaranteed to yield positive real returns above inflation. The video concludes by emphasizing the importance of cost-effective hedging strategies to protect portfolios against further interest rate volatility or market downturns, rather than relying on predictions that often lead to substantial losses. Ultimately, the message is one of caution and adaptation: investors must acknowledge that the era of easy money is over, prepare for a more volatile environment where bonds offer attractive yields but carry risk, and consider defensive measures to ensure long-term resilience regardless of whether interest rates continue to rise or eventually fall.

Read the full video transcript

Good day fellow investors. There was this nice comment on LVMH stock about the 6% interesting free cash flow yield. However, everything changes with the 5% treasury yield. Thank you for all the great comments. Sven is a little bit sick, but he will be back very soon. Thank you. The key factor to discuss today is this. the US 10-year Treasury surpassing 5%. We have been enjoying declining interest rates since 1981. Declining rates push asset prices higher, make financial conditions easier, easier to buy a house, easier to do everything. Then we had money printing more debt on the 2007 debt crisis that peaked with free money in 2020 and the pandemic that lasted a while and then we had rising interest rates. inflation is transitory this blah blah blah and now we are above 5% where we have touched that in 2006 2007 but to go to standard higher rates we need to go to the 1990s and now this has a lot of implications as Stanley Draer Miller would say the 10-year Treasury is the most important price in the world it gives price discovery when it comes to investing. It tells us about inflation, projections, the fiscal situation, possible or impossible to predict what's next. Long term, it is more or less possible. We know the fiscal situation. It will depend on whether the fiscal situation will change or not. Highly debatable. That's why I would put it impossible to predict. Hopefully the fiscal situation will change. But if we look at the budget outlooks, the economic outlooks, what is priced in by the market, we see that the numbers are clear for deficits to just keep on growing, to keep on surging. Nobody cares. That will be okay. But then the bond market says, I might disagree with that. We have real inflation expected to be below 2%. We have growth 2% 1.8% no recessions everything good. Inflation going down to 2%. This has been the expectation since like ever. It hasn't happened in the last five years. Unemployment rate stable. And here is the Congressional Budget Office Treasury notes projection 10 year at 4%. Now it's already at five. When it comes to the budget outlook, the deficit, the long-term deficits are expected to be at 6%. However, if the Treasury is at 5%, this changes immediately and this leads to higher deficits in the future. and then also in changes expected growth and everything. But let's just start with a little bit of investing basics. 5% 10-year treasury, the risk-free rate. We are looking at LVMH stock at a discount of 46% to its recent peak, free cash flow 6, 7%, but compare that to 5%. Then we looked at some UK home builders. I have looked at all of them. Video coming soon. Mortgage rates higher, interest rates higher, less demand from homes. Yes, if everything turns, there is huge upside there. Las Vegas properties gambling. The interest rate was 5% as the treasury now gives you 5%. It's simple that the stock goes down now the yield is 7%. If treasuries go to six, this will go to eight. Nine. The S&P 500 is unaffected because it is in an AI bubble. Asian stocks are affected. Everything is cheaper now. There no AI bubble there. This is a specific business situation. Similarly with higher interest rates in Europe, we have Vonovia going down and also McDonald's going down because the dividend yield is not attractive at 2% not even at three will have to go to four or 5% to compete with the treasury and that's why McDonald stock is having a rough time. These all these things can boom if interest rates go down McDonald's will go up. But that is the big question if further even on AI. This is something very nice. This is the Google 225% 50year bond issued in 2020. Look at the coupon. It was issued at 225 and now the yield is 6%. Those who paid 100 in 2020 now see a 50% loss on the value of that bond because the yield now is much higher. Google used to be able to borrow at 1 2% for these eternal decadel long bonds but now that has changed and Google has to pay 6% for that. This is very important. If you're borrowing 100 million, it used to cost 2 billion per year. Now we are at 6 billion per year. That simply means less investments ahead. Mortgage rates climbing to 7% completely different than borrowing at 3% for 30 years, less housing, less everything. That would push interest rates lower. But the US has uh debt situation and therefore they need to borrow more high demand for borrowing and that means that interest rates cannot go lower. This is because the government has been spending like drunken sailors for the past decade and more and that works until that goes up to 80% GDP. Up to 80% GDP it is stimulative for the economy. More than that, the interest cost over time starts to bite, squeezes other investments, squeezes other growth and then afterwards it's becoming negative which is exactly what we are seeing now. Now we are still on very low interest costs for the US government. The deficit is huge almost two trillion forecasted to remain such nobody cares. However, just simple mechanics tell us the story is different. If we put the four 5% interest cost on the US government debt, this 1 trillion in cost quickly turns into two trillions. So on top of it, this 40 trillion will go to 50 trillion and therefore you can simply over the next few years add 1 trillion of just interest cost to the US federal budget picture that is unsustainable. Government strategy is just to grow out of this without painful cuts targeting 3% gross domestic product growth 3% inflation and that is how you can hold 6% deficits. However, this is just a bet because if you can't grow at 3%. Because the interest burden, cost burden is too high to keep on stimulating the economy. That will be ugly. And politicians simply don't care about that bet because just always look at the incentive. They just want to do their mandate. Some have the goal of not seeing their kids go to jail. Some others just are doing the best what they can. But okay, when it comes to investing, I think that predicting is impossible. I have been looking at things for the last decade. Nobody got it right. We don't know. We know that AI is still driving the growth. And I'm not saying if AI stalls, I'm saying when AI stalls. Because if AI is so smart, it can do itself cheaper. And that will destroy return on investment. All what will be left is that recession and higher interest rates because if you're going to print yourself out of it more inflation then the market is already demanding higher interest rates. Always any crisis once you open the genie of money printing will be reflected with more money printing and that is already reflected in higher interest rates. However, bond holders I think it's still a risk. We don't know if rates will be at 8% 5 years down the road, 5% or 2% where all these bond holders will make a lot of money. How? Remember the Google bond? If you buy at 45 now and interest rates go down to 3%, your bond will double in value. So, you have a 6% yield and a 2x return if interest rates go down. This is getting interesting, but it's still a bet if interest rates go higher. That is the nature of the bond market. So the market is now pricing in higher risks, but also this is a very attractive bet that keeps interest rates still low. The ugly is not priced in. If they cut the budget deficit to 3% immediate recession, no politician would do it. Would look like Europe. And the fact is that Europe has been stagnating for the last decade or so. But that's just because US growth is that fueled. This is the difference between Euro area growth and US growth. You can see a clear divergence there. But what happened? The Euro area peaked at 90% that to GDP and then they said it's enough. The US is just going past that. And this is the reason why alongside the money printing, the low interest rates and everything, US economic growth has been better. Unfortunately, that is not sustainable. I wish I could give you an answer that I could look smart, do this, do that. I personally hope things remain unsustainable for the next 100 years that we don't have to deal with the consequences with the ugliness of this financial bubble bursting. However, when it comes to investing, if you want to avoid gambles, one must be hedged, which leads us to cost effective hedging, which we discussed here and there. I wish I could tell you you can hedge your portfolio with gold and gold miners like I did nine years ago when I was younger and skinnier. We discussed simple SAP 500 put hedges. So here a commentator lost 200k. The fact is that he lost that. But you want to lose when it is a hedge. You're limiting your risk and you're keeping part of the upside. I will have to go back to safe haven March pit snuggle when I will feel better. You can expect a video to see where are the options to be hedged now in a way that we with certainty increase our long-term returns no matter what happens. I want to finish this discussion with Serg's comment and the comment is that more money has been lost trying to predict crashes than just investing. He tried to predict and uh he made a big mistake. Okay, he's now going more into index funds perhaps. I think that might again show as a big mistake if the situation changes. But here the message is just keep on investing and you will do well. I have a little doubt with this projection because it is biased by the US market since 1981 since interest rates have been going down. If we go to the Japanese market, 38,000 in 1989, 8,000 in 2012. Then the market buying by the Japanese, all this inflation has boomed. But that's a different story. US market 68% down in 20 years in real terms from the 1929 peak. 63% down in real terms in 15 years from 1968 to 1982 real terms. Then 60% down to 2009. Those are huge declines and you can't tell me just be invested wait 25 or 20 years and then you will make some money. We are all biased by those who bought in 2009 and enjoyed this. Let's just revert this last boom to normality. When the Fed started printing money, printed saved everyone's behind. Then we are now in the fourth year of an AI bubble. Without this AI bubble, S&P 500 earnings would not be at 300 because those are fake given the AI situation, the entropic adjustments, open AI. Let's say those with a fair recession would be at 200 now times a fair P ratio of 15, which is the historical average. The S&P now would be at 3,000. Adjusting for the peak in 2000, 25 years later, being at 3K, that's a return of just 2.8%. add an average dividend of 2%, you are at 5% long-term returns, which circles us back to the start of this video and the 5% 10-year Treasury. Now, the question is, do I invest in stocks overvalued? I can be down 60% in real terms in a decade versus the risk-free rate or should stocks be repriced? Because even if you get 5% from stocks over 25 years, compare it to this, you are still at a big real return of zero above inflation, above the real risk-free rate. So this is a very important number. We'll explore new venues. Unfortunately, a lot of work with cost-effective hedging, but we'll see where it gets us. Thanks for watching. I'll see you in the next