Dear God, Please stop talking about 1994-95

Last night, the comparison came up with recent selloff action and 1987. But the more frequent relative comparison from the perma-Bullish camp is 1994. That’s the year that gives some folk — most notably, Don Hayes and James Cramer — comfort in the belief that the market is safe from a major correction at this time.

Ryan Fischer destroys that argument. I thought his observations on this frequent Bullish comparo between 1994 and today were  very astute. Since he does not publish anywhere else — and I liked his piece a great deal — I offered Ryan the Big Picture as a platform to publish this.

As always, feel free to comment . . .

Dear God, Please stop
talking about 1994-95
The Winds of Cost of Capital

By Ryan Fischer, 5-20-06

Please, please, I beg of you:  quit talking about 1994-995.
2006-07 has no similarities whatsoever — except in your hope.

Does anyone
remember what the bond market did in 94-95? Anyone? The yield on 10 yr
treasuries went from basically 5.5% at the beginning of 94 to 8% by year end.
That being the number the bond market erroneously thought the FED would go to.
By the end of 1995 the yield on the  10 yr was back at 5.5% a dramatic easing of financial conditions. And, on cue, assets went wild, housing and consumption caught the wind in their sails
coming off the bond market and off Risk ran.

Consider: For us to
experience the same winds of easing of financial costs today yields on 10 year Treasuries (currently 5-5.2%) would have to decline to 3.5-3.7%. What kind of
macro environment would we be in if 10 year Treasuries were yielding 3.5-3.7% six
to twelve months from now? Hello deflationary soup!! That or some crisis that
has convinced Helicopter Ben to deploy the "Unconventional Measures" he talked
and wrote about during his emergence. Friends, if the Fed is buying 10 year
Treasuries and causing a 3.5-3.7% yield we might as well take the stars off our
flag and replace them with a hammer and sickle.

A forewarning: Whenever you
hear or read about Unconventional Measures from the Fed or the Treasury think
State Interference in Free Markets. And we all know where that leads and ends.

But, I digress, as
this missive is primarily about the cost of capital, its percentage change and
the effect that has on risk assets.

Whenever you hear
someone mention historically low interest rates while supporting their bullish argument for whatever risk asset they are
buying, holding or selling, immediately mark them down in your book as
financially illiterate. (Note, this argument is often heard from the CEOs of
public builders, their real estate brethren and the sheep who follow, plus
equity pushers.)

Let me say this: It
is not the absolute level of the rate of interest that matters to those who
allocate capital, it is the relative rate of change

Let me elaborate: Everyone likes to
pull the grandpa "I remember 15% interest rates in 1982, so 5% today is really
historically nothing to be afraid of" (Again note; This is another favorite of
anyone selling, holding or pushing real estate). Lets think about that
intellectual construct for a second and see if, as a person who allocates
capital, if it would sway where I push my dollars.

Because interest
rates were around 12-15% in 82-84 and today they float around 5-5.2% (ten year Treasury yields on both) I therefore should be more willing to employ my capital
in risky assets because money is so much cheaper today than some 22-24 years

First, let me say I will not even touch on the subject of
valuation, though the argument about then vs. now should be clear to any open seeing eyes.

Rather, let us focus on the cost of capital. As a
speculator, entrepreneur, investor, etc..etc..those absolute levels mean
nothing to me. For all I care, interest rates could have been 80% in 82 and the
argument about historically low interest rates today still will not sway me. In
fact, I’ll tell you I’m more excited about a 10%, 9%, or a 8% rate of interest in
85, 86 and 87 than I am about a 5% rate of interest in 2006.


Its obvious, isnt it? 16% in 82 to 9% in 85 is a huge, huge
tailwind at the sails of risk assets. This is a dramatic easing of financial
conditions. Also, trust that asset prices failed miserably for many, many years
to reflect this change. Such are the effects of psychology and the enhancing
fruits of under-valuation. The world is nearly without clouds when interest
rates fall so dramatically (kind of like 2000-2003). Is the world equally not
dark vs. 85(15% in 82 to 9% in 85) or as sunny as 94/95 (again, 8% to 5.5%) now
that rates have gone form 1% to 5% on the short end and 3.5% to 5-5.2% on the
long end.

Based on the cost of
capital, when are you a buyer? When interest rates decline by 40% (15% to 9%) or
increase by 45% (3.5% to 5.07%)?

To risk assets, the
cost of capital is like the wind. It is the change from the start of the race
that matters, the more headwind the more trouble, and the more wind one can
summon to their back, the faster the ship sails.

God what I would give
if this was the mind frame today. Imagine if after an ever bullish provocateur
sighted historically low interest rates as part of their argument if the
financial journalist queried them with Sir/Madam, are you saying you are more
of a buyer when the cost of capital has gone from 3.5% to 5% than you are when
the cost of capital has gone from 15% to 9%?  Imagine.

But always know which
way the winds of the cost of capital blow.

-Ryan Fischer
Red Fisch, LLC



Ryan Fischer manages assets and capital for his family and a
few private clients out of Denver, Colorado. He is long physical
commercial real estate, short paper commercial real estate, long gold and short
IWM. He can be reached at


What's been said:

Discussions found on the web:
  1. FY commented on May 23

    I remember Don Hayes back during the 2001-2002 bear market. He kept on citing how the ARMS index (I call it the ARM PIT index) was so oversold and that was very bullish for the market. He tried calling bottoms way too early. As far as I am concerned, he totally discredited himself during the bear market. Better to fade his opinions.

  2. Barry Ritholtz commented on May 23

    The Arms index did give a lot of false signals during the crash — to his credit, Dick Arms created an oscillation measure to strip out the false positives . . .

  3. Mike commented on May 23

    I went long with some QQQQ calls yesterday.

    Take the spike in VIX and find the prior spikes from the last 4 months. If the difference between the two is at least 4% (it was on Friday/Monday):

    Since 1986 you can count on the Naz being at least 5%
    higher when this occurs within 4 weeks of the 2nd spike.

    I’m getting greedy.


  4. vf commented on May 23

    i wish he would differentiate between cost of equity v cost of debt. cost of debt is rising but is cost of equity? it seems like many companies with high leverage have been doing better due to the lowering of the cost of debt v the companies with no leverage who have a higher cost of equity.
    many activist have been encouraging boards to adjust their capital structure (lever up) to lower their cost of capital at the low in interest rates. what will be teh result when cost of debt rises and cost of equity falls?large cap tech companies come to mind as ones who have avoided debt and have seen multiples contract. will they be rewarded as this changes?
    if anyone has any comments on this i’d appreciate the insight.

  5. joe commented on May 23

    cost of equity is a figment of the academics mind. it can’t be precisely determined, which is why the capm and wacc and all that nonsense are just that, nonsense. to me, cost of capital is nothing more than the rate one uses to discount cash flows back to the present. in that regard, the discount rate should equal my required rate of return for taking the excess risk of owning something other than cash. whether the asset being purchased is volatile, and therefore has a high “beta,” or not is completely irrelevant to the discount rate one should use. thus, the whole construct of the cost of equity and cost of capital is fundamentally flawed.

  6. jim commented on May 23

    My confidence in Bernanke falls a bit more each time I see him.

  7. Mark commented on May 23

    Well you bulls out there need to do better than THIS. This is pathetic for Turnaround Tuesday.

    My miners are workin’, my oils are workin. But that ain’t good for the market.

  8. B commented on May 23


  9. Mark commented on May 23

    I think I’ll check on the status of this rally later. Maybe about June or so.

  10. B commented on May 23

    We’re likely to get more buying as the worm turns later today and maybe tomorrow if we hold reasonably but this is pathetic so far. Same ole same ole. Metals, metals, metals and oil. Nothing else. Transports got a big ole smackdown after raring to go yesterday.

    I think those invested internationally are cruising for a bruising unless it’s Europe on a falling dollar theme. Japan looks shaky as well. Russia down a cool 10% overnight. Templeton Russia Fund, TRF, was a killer long, up 130% in a handful of months but those still holding are being crucified.

    So, what happens next? Equities weak? Where do the hedgies make their money? Most are glorious long funds that really aren’t very good at hedging so what will they chase for their returns with weakening equity markets? How about one last gasp in oil to put the final nail in the global economy? Goldman superspike? $100 by end of year? Any takers?

  11. clunk commented on May 23

    Oil up $3 since goverment hurricane prediction came out. Nice job. With a government like we have we don’t need any enemies.

  12. Gregor Samsa commented on May 23

    Trying to trade this beast will grind your capital like Extra Lean Ground Beef………There’s no real firm bid and doesn’t feel like many shorts in the market. They really need to close this strong or another dive is in store.. So many flippers trying trade the bounce…

  13. GRL commented on May 23

    Wow — Another failed attempt at a rally, punctuated by a drop in the last half hour.

    I’m no technician and can’t say for sure what this means, but I’m kind of floored. Can anyone tell me what it means?

  14. Faisal Laljee of commented on May 23

    Comparing this era to earlier periods is ridiculous. Productivity, globalization and permanently lower interest rates make that distinction impossible. I think the market has a lot of legs here and the shakeout is almost complete. Another 1% or so lower vs 5% higher is the risk/reward scenario.

    — Faisal Laljee

  15. Bobby commented on May 23

    the fed still hasnt figured out how to cause the real estate market to crash. if this were to happen all of bernanke’s problems would go away. and then he’d have a new one. massive foreclosures and thousands of hedge funds going belly up.

  16. Mark commented on May 23

    It’s different this time!

    Maybe. But very likely NOT.

    Change in market psychology boys. Don’t fight it.

  17. whipsaw commented on May 23

    I would speculate that one possible reason for the late afternoon selloffs is avoidance of the risk of overnight bad news from Asia that could lead to a gap-down open well below stops. Or maybe morning buyers are just doing a little scalping while they wait to see what develops.

    Speaking of stops, $SPX actually managed to close a little below its 200 day MA today. That is usually a Bad Thing since a lot of daily trading systems may view it as a penetration and act accordingly. There should be a cluster of both stops and limit buys around 1240-45 which would lead to a lot of activity, but the 200 MA is now a roof instead of a floor and many of the buys will be “buy to cover,” so I think that by the time the dust settled, $SPX will either be within a point of where it was at the close today or will have hit the next support level around 1230.

  18. Troy commented on May 24

    After this trendline bounce I am trading the failure of equities to continue. This is a tough time to be in stocks and bonds. I am bullish on being in a money market account.