'"The Most Important Price of All"
Plus, reflexive markets, dancing leaves and
lessons from the world of artificial intelligence...
by Bill Bonner And Joel Bowman
"Come little leaves said the wind one day
Down to the meadow with me and play.
Over the meadow they danced and flew
Singing the sweet little songs they knew."
~ Old folk song
Baltimore, Maryland - "We kept a fire burning in the kitchen while we worked outside this weekend, tearing down a “run in” for the horses in order to recycle the materials for a larger chicken coop. The horses are gone and the chickens are still here; they need a bigger house. We built the “run in” (a small, open barn) about 20 years ago. Pulling out the nails, we wished we hadn’t done such a good job. The air was crisp. The wind blew. And the leaves danced and flew.
Meanwhile…We turn our attention to the financial world…the world of prices. Executive Summary: They dance around too. Forbes: "Oil Prices Plunge As Economic Woes Intensify—Here's Why That Means Gas Prices Could Soon Fall Below $3 Per Gallon." "Oil prices plummeted to 10-month lows Monday morning after stark warnings from Chinese officials shed light on the nation's increasingly worrisome Covid outbreak—highlighting the uncertainty shrouding the global economy but also fueling hopes that gas prices may fall below $3 a gallon for the first time in 18 months. With oil prices tumbling more than 18% this month, the nation's average gas price has fallen in tandem, shedding nearly 12 cents from a week ago to $3.64 per gallon, GasBuddy reported Monday."
What’s going on? What happened to inflation?
Blackouts Ahead: The oil industry is huge, mature, complex…but it still gets goosebumps when it listens to the news. And all markets are “reflexive.” They react. They adjust. When it gets cold, they put on their coats and hats. Lower prices cause producers to cut back. Higher prices cause them to increase output. And then – what ho! – prices go down again.
But not all parts of the energy market are dancing to the same tune. Supplies of diesel and heating fuels are said to be running low – at least in the Northeast. Bloomberg reports: "A Quarter of Americans at Risk of Winter Power Blackouts, Grid Emergencies." "The electric grids at most risk of supply shortfalls are in Texas, the central US system stretching from the Great Lakes to Louisiana, New England and the Carolinas, the North American Electric Reliability Council said in its seasonal assessment Thursday. Severe weather may stress grids by causing demand to soar while supplies of natural gas, coal and back-up fuel oil are all tight, leaving little room for error, according to the report."
And look at the rockin’ and rollin’ in the used car market. Bloomberg: "Online car dealer Carvana Co.’s shares are careening toward an all-time low as investors grow more concerned about the continuing decline in used-vehicle prices. The price of the company’s stock fell as much as 14% to $6.90, on pace to close at a record low. Carvana, which was once touted as a disruptor in the used-car dealer industry for its online sales, has seen recession-wary investors flee this year from risky and expensive growth stocks."
Carvana is down 97% from the top. S&P earnings are down 10%, year-to-year.
Too Kind, Too Kind: In housing, too, rising interest rates and falling prices are disrupting the disruptors. Zillow, for example, has been cut in half from its February high. (Joel has more on the Zillow story, below.) The median price of an existing house has dropped 8% since June. And building permits hit a 26-month low in October. Other price news: Fertilizer is down 40% since March. Cranberries are down 14%. Global freight rates have dropped 73% from their peak.
But the price we watch most closely is the price of credit. There, it was the Fed who disrupted the normal marketplace by holding rates below zero, in real terms, for more than 10 years. Normally, prices dance to tunes called by the real economy. But in the interest rate market, it goes the other way; the Fed fiddles interest rates and arms and legs start shaking and shimmying all over the country.
Fed governors were so happy when they could hold their key rate down…and make everyone at the party happy too. But excess generosity begat excess debt…especially of the junk variety. And now, it’s the Fed that is being disrupted.
The first leaf fell back in the summer of 2020, when the yield on the 10-year treasury hit a bottom below 6/10ths of a percent. Now, a chill wind blows the yield up towards 4%. At that rate, the federal government gets disrupted, too. The 10-year Treasury is the basic brick of the whole capital structure. And if the entire edifice of federal debt now in private hands – $24 trillion worth – had to be refinanced at 4%, the resulting outlay would be more than the defense budget.
But everything takes time. Debt may be marked to market every business day, but it is only refinanced as it matures. Federal debt has an average maturity of 6 years…so about $12 trillion will have to be rolled over before 2028. This, along with trillion-dollar deficits, will most likely force interest rates higher still. As the financing and re-financing continues, yields will keep rising. By 2025, US 10-year Treasuries could easily yield 10% or more…and millions of households and businesses would be bankrupt. Who knows what cranberries will cost then?"
Joel’s Note: "Special message to artificial intelligence gurus, climate modelers and Thanksgiving turkeys alike: The past does not equal the future. It’s been a year since Zillow, the online real estate marketplace, learned this lesson the hard way. Mashing together multiple gimmicky ideas, the company launched its iBuyer (or “instant buyer”) algorithm in 2018, following companies like Redfin, Opendoor and Offerpad into the dubious world of large scale property flipping.
The idea was to use Artificial Intelligence (AI) algorithms to predict the future value of real estate prices based on past trends and current trajectories... and to make automatic (“instant”) offers on deals deemed to be “priced below model.” The concept seemed appealing enough... at least to the team of programmers and coders responsible for writing the algorithm. No need for site inspections... in person viewings... shaking hands with the owner... understanding the socio-economic dynamics of the “location, location, location.”
In fact, human beings could step aside altogether. With iBuyer at the ready, it was simply a matter of plugging in the data and letting the past inform the future. What could go wrong? Lots, it turns out...
Hook, Line and Algorithm: For starters, prices could go down as well as up. So when the market began to shift and cool, during the early days of the pandemic, iBuyer was still locked in “everything is awesome” mode. This caused it to significantly overestimate the market value of thousands of properties, which it promptly snapped up, “thinking” it was getting the houses at steep bargains.
In machine learning, this problem is referred to as “concept drift.” In human learning, it’s just called “real life.” Turns out, markets are complex beasts, with millions of highly variable individual inputs, any one of which can cause a cascading set of unpredictable eventualities.
The over-excited iBuyer algorithm ended up acquiring more properties in the back half of 2021 than it had in the previous two years. When “adjustments were made” (and, no doubt, some programmers shown the exit), Zillow was forced to reduce the estimated value of the houses it purchased by more than $500 million.
As Zillow attempted to unload the now-overvalued assets (which bear significant carrying costs), it quickly found itself selling into falling markets across the country, further exacerbating its own problem. At one point, Bloomberg reported that Zillow was attempting to sell 7,000 houses in order to recoup $2.8 billion in losses. That didn’t go well. Zillow is down 46% year to date.
We are reminded of this important lesson around Thanksgiving every year, when we remember the fattened turkey, blissfully pecking around the farmyard and musing nonchalantly on his life so far, with nary a meat cleaver in sight. As they say in the financial publishing industry, “past performance is no guarantee of future results.” iBuyers... climate modelers... and other Thanksgiving turkeys... take note."