By Eric Peters, CIO of One River Asset Management
Time Travelers:
“I like sci-fi, but prefer time travel stories to dystopian superintelligence ones,” said Lindsay Politi, our inflation portfolio manager, early one morning, our Bloomberg’s aglow. “Maybe that’s why I still think the better sci-fi tale playing out in real time is happening in the financial markets, not in Silicon Valley with its latest AI advances. Interest rates are the price of time, so, in a way, last decade’s monetary policy experiment was really a time distortion experiment. Crossing the zero bound in interest rates, like exceeding the speed of light with matter, causes our sense of time to become unfixed. Future values and present values converged and became indistinguishable. Time became irrelevant,” said Lindsay.
“Financial valuation, at its core, is about valuing future cash flows,” continued Lindsay. “Taking interest rates near or below zero across almost all-time horizons completely distorted the idea of time in that cash flow valuation process. It compressed present values and future values to the point of being nearly identical. Being able to pretend that time doesn’t matter is alluring but completely unhinged from reality. Distorting the pricing of time doesn’t make time irrelevant, even if it seemed that way for a while, and having to consider time again as an extremely relevant variable is destabilizing for today’s markets, quite literally.”
“Now that time matters again, we’re starting to realize that a lot of money we thought was on hand is trapped in the future,” said Lindsay. “You hear it all the time from the house you no longer want to sell because the mortgage rate is too low, to the PE deal you’re holding longer than you anticipated. Good or bad, people have all kinds of financial holdings they thought they’d be trading in the present but it’s now too expensive not to hold well into the future. It is creating all kinds of unexpected illiquidity and distortions. It’s not that the capital doesn’t exist. It’s just that it exists in a different time than we thought it did. And inflation is a catalyst that exposes these time distortions.”
“All this trapped capital means inflation will be worse than most think,” said Lindsay. “There are supply issues, capital investment is needed to resolve them, but that capital is locked up in investments that we now realize are much longer term than originally anticipated. Negative and zero interest rates are so distorting that even a slight move away from that was always going to create a substantial shift towards value of the present — liquidity, cash, current cash flow, etc. Inflation itself is all about time preference for the present, wanting the ability to buy today before it’s more expensive tomorrow. This natural shift towards wanting assets and consumption in the present creates an inherent inflationary push that’s hard to anticipate. It means that prices rebound more quickly on dips than we expect.”
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