Taps Coogan – February 2nd, 2023

Legendary trader, risk analyst, author, and the patron saint of options traders, Nassim Taleb, recently sat down for a long format discussion about markets with Bloomberg. (Excuse the audio/video problems with the recording).

Some excerpts from Nassim Taleb:

“Let’s start with Finance 101… happiness equals positive cash flow. That notion disappeared mysteriously in 2008… What happened then was… the Federal Reserve somehow, extremely amateurishly, decided that lowering rates to zero would fix the problem. So, they put interest rates… effectively at zero… Interest rates at zero are not proven to be more effective than interest rates at 3%, but guess what? Once you put them at zero, it’s very hard to raise them. What did interest rates at zero bring? Tumors… There is something called interest rates at zero and something called real-estate that created illusionary wealth of over $100 trillion… They fixed an economic problem, namely too much debt in 2007, with what? More debt. They fixed an economic problem with a monetary solution that was supposed to be a short term thing. Keynes himself understood it was supposed to be a temporary measure…”

“You spend 15 years in that environment (Zero Interest Rate Policy – ZIRP) and you don’t know finance. So they don’t realize what’s hitting them. So you have to go to people that have grey hair, or have a library, or have a grandfather… someone to talk to to see what happening. It is much worse than you think. All of these companies were using the stock market, or private equity, or some ’round twenty’ investor, as a cash machine… Now you have to make money… Now we have the phase of bleeding. What is bleeding? It is earning less than 4.75% because that’s where short term interest rates are. If you are earning less than 5%, you are losing money. If you have to borrow money you have to pay 5% plus whatever the risk premium is… Not only do you have to make money, you have to make more than the discount rate. The second problem, and it is a lot worse, is people think that the Fed by raising rates has engaged in a temporary measure… The Fed is going to keep raising rates or keep rates higher than zero because they discovered ZIRP doesn’t work…”

“I believe the stock market is way too over-valued for interest rates that are not 1%. Unless they miraculously bring back interest rates to 1%, which they won’t be able to… it’s unsustainable. Why would you put your money in a stock that give you a 2% dividend yield, if you are lucky, when you can get 4.75% from the bank while playing golf? Explain to me the logic…”

There is much more to the interview, but the punchline is that even if inflation declines, Mr. Taleb doesn’t see interest rates going back to ultra-low levels again and thus a further revaluation of financial assets is unavoidable.