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The Most Biased Newsletter Ever

July 22, 2019

On January 28, 1986, I was gathered around a tv with my third-grade classmates and our teacher, Mrs. Bashore.  We were watching the Space Shuttle Challenger mission, in large part because one of the crew members was a social studies teacher from New Hampshire, Christa McAuliffe.

Seventy-three seconds after liftoff, we watched in horror as the Challenger exploded.  I distinctly recall the two separate plumes of smoke diverging as the rockets separated and headed off in different directions.  Mrs. Bashore only left the tv on for a few more minutes before shutting it off to explain what had happened to the brave crew members inside.

This experience as a third grader skewed my view on space exploration because I grew up thinking space missions were basically a life or death coin toss.  With Saturday’s 50th anniversary of Neil Armstrong’s walk on the moon, I decided to watch Apollo 11 over the weekend.  It’s an incredible documentary using only actual footage from the days surrounding the mission.  You should watch it.

Some mind-boggling facts from that first trip to the moon.

  • The rocket was over 360 feet tall, weighing more than 6 million pounds
  • The crew traveled 240,000 miles each way
  • In order to escape the earth’s gravitational pull, it had to travel at 32x the speed of sound
  • During liftoff, Neil Armstrong’s heart rate was 110 beats per minute, while Buzz Aldrin’s was 88 beats per minute. I’m pretty sure my resting heart rate is higher than that.
  • After four days of travel time, they touched down on the moon with 10 seconds of fuel, exactly as planned

One of the things I love best about flying is just the feeling of taking off from a small piece of pavement here and landing on a different piece of pavement over there.  NASA is so precise it flew three humans almost 500,000 miles in 10 days and landed both there and here within seconds of their calculations.  Mind boggling.

I was also impressed by the unifying aspect of the space mission, which stands in stark contrast to the embarrassing chants at a Trump rally last week in my home state.  I think we are ready to come together.  Perhaps it will take something as bold and aspirational as a moon landing to do it (or Mars?).   But those North Carolinians are not patriots, nor do they speak for most.  Neil Armstrong, Buzz Aldrin, Christa McAuliffe are patriots.  I want my kids to grow up to be like them.

I was also struck by how my third-grade experience had shaped my view of space travel.  The Apollo 11 mission was just so… precise.  Nothing about it felt like chance.  It was not a coin flip that happened to come up heads, it was science and math and engineering and courage and vision.  My long held (and dormant) belief had been skewed by the Challenger disaster.

This sent me down a rabbit hole of cognitive biases.  Behavioral psychologists would say I experienced a Negativity Bias from Challenger that influenced how I viewed space travel thereafter.

Cognitive biases.  Turns out we are surrounded by them.


Last Week This Morning

  • 10 Year Treasury climbed to 2.055%
    • German bund down 12bps to -0.33%
    • Japan 10yr flat at -0.13%
  • 2 Year Treasury trended slowly lower to 1.82%
  • LIBOR at 2.26% and SOFR at 2.46%
    • Market still has a 100% probability of cut at month end, with a 20% probability of a 50bps cut
  • While 61 out of 80 companies have beaten EPS estimates, Goldman released a report that aggregated sentiment from more than 4,000 earnings calls over the last year that suggest companies are growing more pessimistic
  • NY Fed President John Williams made uber-dovish comments Thursday, which caused the market to price in a 50bps cut…only to have the NY Fed itself release a statement walking back his comments
  • Iran seized a British tanker
  • Fed-speak effectively confirmed the Fed will be cutting rates 25bps at month’s end
  • Bloomberg News reported that more than half of the biggest 50 acquisitions over the last five years pushed the acquiring firm into junk-bond levels of debt, yet retain IG ratings
  • BlackRock CEO Larry Fink predicts the ECB will begin buying stocks as part of its QE programs
  • Treasury Secretary Mnuchin said the market should not be “worried” about a debt ceiling deal passing, probably because of how well the Dems and Republicans are getting along


10 Year Treasury

How will the 10 Year Treasury behave if the Fed starts cutting rates?  If I knew, you wouldn’t be reading this right now because I would be prepping to make another run at a Super Bowl ring as the owner of the Philadelphia Eagles.  But as always, ignorance doesn’t prevent conjecture.  Fortunately, I am on a first name basis with the Overconfidence Effect, a cognitive bias whereby some people (not me) exhibit excessive confidence.

In a nutshell… it depends.  And isn’t it that sort of hard-hitting, no holds barred analysis you come here for?

Let’s take a look at post-crisis rate movements.  In the graph below, LIBOR is the blue shaded area, while the 10 Year Treasury is the green line.

End of 2008

The Fed cut rates to 0% and within 6 months the 10 Year Treasury had climbed from 2.15% to 3.95%.


The Fed commits to keeping rates at 0% for at least two years, and within six month revised that commitment through mid-2015.  Within a year, the 10 Year Treasury had fallen from 3.18% to 1.41%.

In one scenario, the T10 increased 1.80%.  In the other, it fell 1.77%.  Why the different reaction?

Source: Bloomberg Finance, LP

End of 2008

During late 2007 and early 2008, the market had suffered from the Ostrich Effect.  You guessed it – head buried in the sand to avoid a negative situation (I wonder if psychologists play drinking games to come up with these names?).

But by the end of 2008, the Fed Put was in play.  The Fed had cut rates to 0% for the first time ever and it was bailing out banks left and right. The S&P rallied from 600 to 900.

I think the 10 Year Treasury climbed nearly 2.00% in six months because of market belief that this unprecedented Fed intervention would lead to inflation, growth, and therefore higher rates.

Those clinging to a Hindsight Bias will tell us they knew all along we were headed for a decade of 0% rates.  I can only assume they also got in equities at S&P 600.  Must be nice to be right all the time with the benefit of hindsight.  I, unfortunately, have a newsletter people can send to me to remind me of all the times I am wrong.

Do you know what the lowest 10T yield was prior to the crisis?  3.51% in June 2003.  Before that? 3.85% – in 1962. 

The 10 Year Treasury testing 4.0% could have been the result of the Regression Fallacy, which Wikipedia tells me is “assumes that something has returned to normal because of corrective actions taken while it was abnormal.”   Sounds about right.

But markets also could have been exhibiting Risk Compensation Bias, which is the tendency to take greater risks when the perceived safety has increased.  My favorite example of this is the study that found drivers that wore seatbelts drive faster than those that do not because they believed the seatbelt makes them safer.

If the Fed is willing to backstop and bailout struggling firms, why not take greater risk?

If the market interprets the upcoming rate cuts as the sort of intervention that will result in a reversion to the mean and allow more risk taking, perhaps the 10yr Treasury will climb.

But even then, nothing like it did in 2008 (there’s the Overconfidence Effect rearing its ugly head again).


Unlike the previous example, the Fed didn’t actually cut rates in mid-2011.  I am highlighting it because, for the first time, the FOMC really used forward guidance in lieu of an actual rate move.  The Fed publicly committed to keeping rates low through at least 2013 (two years).

Three years had passed since the peak of the crisis and the economy was still struggling.  The Fed’s statement was an explicit admission that emergency monetary policies were not working.  It didn’t encourage risk taking like it had in 2009, it encouraged fear.

The 10T plunged.  Within six months, the Fed extended its timeframe from mid-2013 through mid-2015.  The 10T fell further, eventually reaching its all-time low.

With the wounds from 2008 still fresh and no light at the end of the tunnel, markets were in full-blown Risk Aversion Bias. Investment decisions were made in an attempt to avoid unlikely losses.  There was maybe even a touch of Pessimism Bias, which is exactly what it sounds like.

If markets interpret the rate cut(s) as an admission that the economy is more fragile than we believe, then the 10T could easily blow through 2.0%.

But previous results don’t predict future performance, right?  A behavioral psychologist might refer to this as Information Bias.  I am seeking out information even though it can’t affect a decision.

I’m pretty sure most newsletters could fit into this category.



It was 2015 when a client first mentioned experiencing inflationary pressures in development costs.  Since then, it has become much more common place.  It usually comes in reference to exasperation that the alleged inflation data continues to come in soft.

Here’s a graph of CPI over the last 20 years.  I am intentionally choosing this over Core PCE because I frequently hear, “Sure, no inflation.  Has the Fed checked the cost of milk or gas lately? Or my development costs?”  There’s a tacit accusation that Core PCE fails to truly capture inflation.

What does this graph show?  Since the Financial Crisis, inflation has struggled to stay above 2.0%.  Fact.

Source: Bloomberg Finance, LP

“Development costs!  Leases!  Occupancy!” I can hear the collective chants already.

Saliency Bias is overstating the effect of something because it happened to us.  If my project has inflation, inflation must be everywhere.

I suspect more than a few readers are getting ready to send emails.  And that’s because we also experience Conservatism Bias.  Don’t worry LA readers, I’m not suggesting you are suddenly GOP’ers.  Conservatism Bias means we tend to revise our views insufficiently when presented with new information.

In other words, if 30 seconds ago you believed inflation was rampant, the previous paragraph is not going to change your mind.

In fact, there’s a chance I have triggered the Backfire Effect, whereby you are digging in your heels right now and believe more than ever that inflation is rampant.


Inflation Lacking, 10 Year Tracking

One of the more adorable cognitive biases is the Rhyme as Reason Effect.  Sounds silly, right?  But by making that statement rhyme, you interpret it as more accurate.  Maybe that will help overcome the Backfire Effect.

I have been arguing this year that the 10T is inflation-constrained.  That’s why I believe a trade war resolution alone won’t send the 10T materially higher.

The graph below shows CPI (blue) vs 10T (green) in the five years following the financial crisis.  Couple of takeaways:

  • When CPI plunged into negative territory, the 10T did not follow suit for the reasons I addressed earlier (Fed rate cuts)
  • When CPI peaked at 3.9%, the 10T was falling for the reasons I addressed earlier (Fed committing to keeping rates low for several years)
  • The 10T struggles to exceed inflation by more than 1.50%. With inflation today at 1.6%, this means a 3.0% 10T is likely the ceiling (and only if everything else breaks right).
Source: Bloomberg Finance, LP

Here’s the same graph, but since 2014.  Same message – inflation lacking, 10yr tracking.

Conclusion – until inflation returns, the 10T will struggle to move materially higher.

Source: Bloomberg Finance, LP

You’re buying the argument that the 10T yield is inflation-constrained, but only because of the supporting evidence and not the silly cognitive bias from rhyming, right?

“We’re too smart to fall for that,” I can hear my readers saying.

What if instead I said, “If the gloves don’t fit, you must acquit.”


Week Ahead

The Fed goes dark ahead of the July 31st meeting next week.  If the Fed had wanted to change market sentiment away from expecting a 25bps cut, it would have done so by now.

Economic data calendar is headlined by Q2 GDP on Friday.  Recall that Q1 surprised to the upside at 3.1%, but consensus forecasts project just 1.8% for Q2.  Thursday brings Durable Goods, which may have a muted effect given everything else this week.  More than a quarter of S&P companies will report earnings.

As my kids like to point out, I am the epitome of the Dunning-Kruger Effect.  That bias states, “The tendency of unskilled individuals to overstate their own abilities.”  Bingo.

But you aren’t off the hook, either.  If you’re reading this, you may be susceptible to Confirmation Bias.  You read this newsletter because it confirms what you already believe, even if its just about how kids sports require more effort than they realize.  So, we’re in this together.

And finally, congrats to Shane Lowry for winning the British Open in front of the home crowd.  What a great story and a great final day.  I suspect the pubs stayed open all night and business in Ireland will be a tad unproductive today…

Then again, maybe that’s just a Stereotyping Bias.


Click to Open: The Pensford Letter PDF