Hurdle Rate Remains 10%

While the equity markets and "shitcos" get giddy about today's CPI print coming in beneath expectations at 7.7% year over year it will behoove everyone to remember that the terminal US fed funds rate is still expected to be between 4-5%.

This 4.5-5.5% is the "risk-free rate" i.e. the least risky way to get a return on money. Meaning that you can buy government bonds risk free--the US isn't going to default on it's debt--and receive 5% per year. So if you are a money manager hunting for returns above that risk-free rate you must clear it on a risk-adjusted basis for it to make sense to not just take the risk-free rate.

In equities, and certainly in growth companies with negative earnings, the risk-adjusted return is going to be at least double the risk free rate. Probably closer to 12%.

In essence, to "beat the market" you need to return 12% per year if government bonds return 5%. 12% is non-trivial in good conditions. 12% is difficult in a rising rates environment. 12% is even more difficult if you're a company losing money in a rising rates environment.

So while it feels like a party today with companies like AFRM and CVNA up 25-30%, it's hard to imagine it lasting because the overnight rate--which determines the risk free rate--as stated by JPowell, will remain higher for longer.

The longer it remains high, the longer that hurdle rate remains high.

This kind of math is what drives institutional money. As a major money manager where are you putting your money if inflation stagnates between 4-5% and the risk free rate is 5%? BNPL companies making loans to people to buy Jordan's or 10y treasuries?