Category: stock market

Coronavirus mailbag

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The insanity of the stock market’s reaction to coronavirus has prompted a few questions in the mailbox.  Let’s see what we’ve got.

“Do you think this is a buying opportunity in the market or do you think there is a deeper drop to come?”  BB from Greensboro, NC

Actually, the answer is “yes” to both.  I do think this is a great buying opportunity, and I also do think there is probably a deeper drop coming.

Long-term, the market is way overreacting.  After yesterday’s bloodbath, stocks are down about 35% from their highs just a few weeks ago.  That seems absurd.  All the companies in the world didn’t lose over a third of their value over this.

Even if you look at the industries that are hardest hit, like cruise ships and airlines, it shouldn’t be that bad.  Maybe they’ll be out of commission for a couple months, and that’s bad, but not 35% bad.  Other industries shouldn’t be nearly that bad.  Grocery stores should be doing just fine (better than fine given the rush to buy toilet paper and hand sanitizer).  They’ll have a little bit of disruption while we work our way through this, but it should be fairly minimal.  That’s all to say, I think things are way oversold and in a year or two we’ll look at this as an amazing buying opportunity.

However, in the here and now I don’t think we’re out of the woods.  There’s so much still unknown, most importantly “when we’ll reach peak infection in the US”.  That’s really the key to it all.  South Korea reached peak infection after about two weeks while Italy still hasn’t reached peak infection after three weeks.  Either way, the stock market will recover.  If we look more like South Korea then we will recover nearly as quickly as it’s fallen.  If we look more like Italy then we will fall considerably more before things turn around.

To directly answer the question, I would buy into stocks but not right now.  I think things are going to get worse before they get better.  There’s a famous saying in investing: “don’t try to catch a falling knife”.  Basically, it means when a stock is falling, don’t try to time it perfectly.  Rather wait until the stock “hits the floor” and things settle.  Even if you miss the absolute bottom by a bit, you’ll still be able to get in when stocks are well off their highs. 

That’s the approach I would take now.  I would keep any cash handy and wait until we confirm we’ve hit peak infections.  Once that happens, the stock market will probably rally 10% or so in a single day.  You’ll miss out on that but you’ll still be able to get in at 20-30% less than what you would have gladly paid a month ago.

“Why is gold going down?  With trillions of dollars reduction in equity, where is all the money going?  Is it liquid, and will it come roaring back when the virus caused business slowdowns stop?”  Uncle Bobcat from Ft Wayne, IN

Gold has been pretty interesting through this.  It was steady to rising for most of the crisis and it was only in the past few days that it started a freefall similar to stocks.

The light blue line is gold and the dark blue line is the US stock market

The short answer is that gold has been falling because interest rates have been cut.  Look at gold’s major falls on March 2 and again yesterday, and those coincide with when the Federal Reserve cut interest rates.

The longer and more interesting answer is that I don’t think it’s clear what role gold plays in this crisis.  In 2009 everyone thought the world economies were going to collapse and fiat currency would become worthless paper.  Hence, people were fleeing to gold as a store of value.

That doesn’t seem to apply here.  I don’t think anyone feels the economy is going to collapse in some cataclysm.  Rather, the economy is just taking a massive body blow.  Things that were worth X before are now worth X less 20-30%.  That goes for stocks for sure but then for a bit of everything else like shiny yellow metal.

With regard to your last question, I do think things are oversold and things will be better.  As I said in the other question, everything revolves around when we hit peak infection.  Once we hit peak infection, I think we’ll have a huge recovery. 

That said, I don’t think we’ll get back to where we were before this all started, and that should make sense.  A huge amount of value has been lost that we’ll never get back.  Those idle cruise ships can never make up that time.  Same applies to restaurants, conferences, sporting events (I know a part of Uncle Bobcat died when they cancelled the NCAA tournament).  That value’s gone and can’t be recovered.

On the other hand, a lot of stuff can be made up.  A lot of the supply chain problems caused by China not shipping stuff will be made up once the factories start humming again.  Same thing with dentist visits, plumbing work, and other stuff like that.

Take all that into account and my sense is that within a year we’ll be at about 3-5% below where we were when all this stuff started.

Coronavirus

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Holy Crap!!!  That’s really the only appropriate response to the craziness of the stock market over the past few weeks.  So over-the-top has been said craziness that I just couldn’t sit on the sidelines any more.  I had to get my stocky back on.

Let’s dive in with what’s really going on, how crazy is all this really, and if you should be freaking out?

The numbers

Let’s try to remove emotion from the craziness of the stock market for the past few weeks and just look at the facts, the numbers.

On February 19, the stock market* peaked at 3386.  The next two days it fell a bit, but then on Monday, February 24, it slipped over 3% and the freefall began.  Since then it has plummeted to 2711, a 20% decrease.  That’s a crazy fall but let’s put that in perspective.

First, before all this began, the stock market was up a bit less than 5% for the year (not bad for two months).  So really we’re just down about 16% year-to-date.  That’s certainly not good, but being down 16% feels better than being down 20%.

Second, despite all of this, we are up about 9% from where we were at the beginning of 2019.  Going back five years, and the market is up about 32%.

You get my point.  This is definitely bad, but I think one of the things that makes it so bad is that the pain has been so focused.  Who knows what next week will bring (I am writing this Sunday night after the cubs finally went to sleep).  Maybe the market is taking another dump on Monday morning as you read this.  But those historical numbers seem decent.  If someone told you at the beginning of 2019 that stocks would be up almost 10% over the next 15 months, I think you’d probably take it.

Historic context

The past three weeks (17 trading days) have been bad, even by historical standards.  But how bad really?

In the past 17 days we are down 20%.  Since 1928, there have been 15 other periods that bad or worse.  Over 90 years, this has been worse 15 times.  That doesn’t seem all that bad, actually.

Of course, that doesn’t mean this happens every six years or so.  It’s much more lumpy.  As you would probably guess, most of those 15 periods come from the Great Depression, eight of them in fact.  That accounts for half of those instances.  Needless to say, the Great Depression was a colossal economic calamity the likes of which we’ve never seen since.  This is not going to be another Great Depression.  Not anything remotely close to that.

The others are a smattering of instances around World War II (1937, 1938, 1940, 1946), the biggest single day fall in the stock market’s history (1987), the dot-com bubble (2002), and the Great Recession (2008, 2009).

This time seems a bit middle of the road compared to those mega-examples.  The graph shows the stock market in the three weeks before the you-know-what hit the fan and the three weeks after.  What we are going through today is in the bright red line.

This gives me a bit of comfort.  Coronavirus had a steeper fall than most, after three weeks (where we are today), it was as good or better than any of those examples.  In the following three weeks thing improved in every case (for the Great Depression it got a bit better as you can see, but then the bottom really fell out).

Of course, it’s impossible to predict the stock market, but I tend to think things aren’t nearly as bad as the stock market’s performance would lead you to believe.  Let’s say I’m 70% optimistic and 30% pessimistic.

The argument for stocks recovering quickly

If you compare what we’re going through to the dot-com bubble and the Great Recession, I think we’re in a lot better shape.

In each of those examples, there were fundamental and systematic problems with the stock market and the economy.  In 2002 there was rampant accounting fraud (Enron, Worldcom, Qwest, etc.) that made it impossible to invest based on trustworthy information, the lifeblood of the stock market.  In 2009 the banking system was collapsing, threating to grind the wheels of commerce in the US to a halt.

Coronavirus just doesn’t seem all that bad in comparison.  Those were deep, dark issues that took a long time to unwind and correct.  That doesn’t seem to be the case here.  In the next few weeks the number of new cases will peak.  Social distancing, warmer summer weather, and the miracles cooked up by the pharmaceutical industry are going to fix this.

If you look at data from China (not a good idea since I don’t trust their data) and South Korea (I trust their data more), this doesn’t last very long.  South Korea started getting cases on February 19, and the US started getting cases on March 2; so we’re about two weeks behind them.  Their new infections peaked on March 3; if ours follow suit we should be peaking this week.  Even if it takes us twice as long to peak, that’s only another few weeks.  That doesn’t seem all that bad.

Things are starting to turn for Koreans positively in other ways too.  People are starting to recover to the point where the total number of people infected is flat—every day just as many people are considered fully recovered as there are new cases.  Also, their death rate is falling precipitously.

Even if it takes us twice as long to peak and then flatten as it did in South Korea, that’s only another few weeks.  That doesn’t seem all that bad.  It’s definitely better than the Armageddon scenario that seemed to be priced into the market right now.

Going into this, the economy, especially the US economy, was quite strong and there’s no real reason to think that will change.  Banks aren’t going to start much stricter lending regulations as was the case in 2009.  You don’t have entire industries that we thought were very profitable and now we know are unprofitable as was the case in 2002.

Once we get the all-clear, there’s no real reason to think things won’t go back to normal, or maybe even better than normal as we work off some of that pent-up demand.

The argument for stocks still facing trouble

As optimistic as things look for South Korea, they look that bleak for Italy.  Italy got their first cases a few days after South Korea, but they have yet to peak.  Everything is on total lockdown and there isn’t an end in sight.

If we end up looking more like Italy than South Korea, that’s bad, obviously.  Reasonable people can debate which is the better analog.

As it stands, in the US, the hits keep coming.  Major components of industry are shutting down (mostly sports, travel, tourism, and conventions).  Very honestly, this became real for me last Wednesday.  That’s when the NCAA announced fans wouldn’t attend the basketball tournament (I had tickets) and the NBA cancelled the season (the NBA playoffs are my Christmas).

On Friday we started an international travel ban.  Yesterday our state joined many others in cancelling schools for kids.

There’s an obvious human cost to all that, but there’s also an economic cost, one that will never be recovered.  You can’t get the revenue for those tickets back, enjoy those cancelled cruises, fly on those cancelled flights.  That’s all gone.  At a minimum that’s probably 3-5% of the value of the stock market.

And that’s if things go right.  There’s a lot of reason to believe that other industries might need to shut down.  There’s also a lot of reason to believe that this might take months rather than weeks.  As those things happen, it will get worse for stocks.

So there you go.  That’s my take on all this crazy coronavirus mayhem.  Sadly, this has given a lot of material for future posts, so you should expect another post from me on Wednesday.  Ha, ha!!!  That’s not sad, that’s great news.

*Unless otherwise stated, I’ll be using the S&P 500 when I refer to “the market”.  For stock data before 1950, when the S&P 500 began, I am using a “proxy” of the S&P 500 that Yahoo!Finance has created going back to 1928.

Top 5: Future innovations that will make a killing in the stock market

Stocky 3 Comments

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Welcome back to my Top 10 list of industries that will create new trillion dollar companies.  On Monday we covered 10 to 6 with: marijuana, fake meat, virtual reality, curing diabetes, and sport gambling.  If you didn’t read it, you may want to check it out.

On to the show.

5. Video conferencing:  This is another one of those things we see in science fiction movies all the time, but what we have today still falls flat.  Today’s technology isn’t always reliable, the cameras aren’t that good, they don’t follow the subject (center it), you have challenges with people talking over each other, and even slight delays make it a farce.

That’s a pretty big list of complaints but the potential is there.  Even with today’s very flawed offerings, you can see the promise.  And there is no question of the need.

When I was a consultant we had meetings about once per month that had maybe 40 people come together.  Let’s say half of them had to fly in.  Flights, hotels, meals while traveling come to about $2000.  Plus you have all the lost time.  To get there and back on a plane takes two days lets say.  If each person in that room makes $150,000, those two days, less the time of the 4 hour meeting is about $1000 each.  All said, just to have that meeting with everyone there face to face costs $60,000 or more. 

Once the technology gets there, you can have those meetings at a fraction of the cost.  Plus, as it becomes more convenient, you’ll have a lot more “face-to-face” calls instead of phone calls or emails.  Obviously communication is much more effective if you can do that rather than just have audio or text.

There’s a ton of money to be made here, and I don’t think we’re really that far away.  It’s just making it as streamlined and simple as making a phone call is today.

4. Online shopping:  Many will say this is already there—Amazon, anyone?  In fact, e-commerce only represents about 10% of retail. 

The big rocks I see changing in the next couple years are groceries and prescription medicine.  I know right now they’re there, but it seems pretty limited.  The Fox household cannot get online grocery delivery from Amazon.  We can’t even get it where we order groceries online and them pick them up from the closest Walmart.  So there’s room for improvement there.

Beyond that, especially as you start leveraging other advances (drone technology maybe, and VR #8) you can imagine a lot of other markets opening up.  If I was smarter I could tell you exactly what it would be.  However, with only 10% penetration, e-commerce has already made Amazon a trillion-dollar company.  As penetration drives to 20%, 30%, and on, there’s no reason to think it won’t spawn more trillionaires.

3. 3D printing:  This is a bit of a backwards technology—the solution came before there was a problem to solve.  At Medtronic in 2014 we got a 3D printer and everyone thought it was super cool but it didn’t do anything.  It was huge (about the size of a phone booth, cost $300,000, could only “print” in one material, and only a few of the guys in the machine shop knew how to use it.  Honestly I think the most use it got was making trinkets for the local elementary school who came to our facility for a field trip.

 This year I went to a “STEM in schools” conference and there was one for $2000 that could print in up to 4 different materials (different colors but all the same material).  Clearly the technology is advances.  Now it just needs that “killer app”.

Again, predicting the future is a good way to look foolish.  Long-term you could imagine a 3D printer “printing” food and body organs, but that’s Jetson’s stuff still probably decades off.  In the more short-term I think it can revolutionize some medical device industries like orthopedics (about $50 billion in annual revenue) and dental crowns ($10 billion), just to name two off the top of my head.  You could also imagine more mundane things like plumbers and construction guys always having the perfectly sized piece. 

2. Solar panels:  Our appetite for energy will only continue to increase.  As political forces curb fossil fuels, renewables like solar become an obvious solution.  Over the past few years, solar has definitely gained traction and grown a lot, but it’s still only about a billion-dollar industry.

What makes me optimistic is that the economics work.  We installed panels on our roof about 3 years ago, and they have a long-term return of about 4%.  Since then panels have gotten better AND cheaper, so a similar system today would cost about 10% less than we paid and generate about 10% more.  That pushes that return up to about 6-8%.  For a risk-free rate, that’s amazing.  Everyone should be doing this.

Also, what makes me optimistic is that there’s a ton of room for growth.  It struck me when I flew in Los Angeles.  On the approach you pass over about 50 miles of urban sprawl.  There’s millions of roofs, and only a small, small fraction have solar panels.  And that’s in LA where the political climate is so pro-solar that they require new buildings have solar panels.  If there’s that much opportunity in a place like LA, imagine the rest of the country and the world.

1. Self-driving cars:  This is the biggie.  Just goofing around with Mike, a loyal reader who predicted this as the #1, I thought this could generate $5 trillion in value.  Now I wonder if I underestimated that figure.  Realizing the dream of a fully-automated car has the potential to be as big an innovation as the personal computer or the internet, and those created a few trillion-dollar industries.

Where to start?  First it will allow the current automotive industry (currently about $1 trillion in annual revenues) to offer a product SIGNIFICANTLY better than available now.  There’s a ton of money to be made there.  If you’re willing to pay $25,000 for an Accord today, how much if that same car drove itself?  $40,000 or $50,000?  More?

There’ll also be a real estate boom.  Real estate just in Manhattan is worth about $2 trillion.  Let’s say 5% is dedicated to parking facilities—that $100 billion just in Manhattan that can get redeployed.  Extend that to every city in the world and your talking trillions. 

Also, there’ll be a boom because real estate in outlying areas will increase.  Today, let’s say a person is willing to commute up to an hour.  So communities that are over an hour away from where jobs are lose a lot of value.  If cars drive themselves, people will gladly commute longer because they aren’t driving, they’re just browsing on the internet or watching movies.  Those communities will drastically increase in value due to higher demand.  Imagine that across suburbia and you’re similarly talking trillions.

Plus roads will last longer because computers don’t drive like idiots they way people do.  Tires and other auto parts will last longer for the same reasons.  The auto insurance industry just in the US has about $300 billion in revenue and that will be turned on it’s head.

Oh, and there’s that little thing call humanity.  The 35,000 annual fatalities and 3 million injuries will fall dramatically.  That’s probably worth a couple trillion right there.

I could go on and on for these, and I am sure there are others that are equally promising.  The pint is the future of investing is bright.  There are going to be amazing companies that are going to continue to create amazing value for those who are invested.

Top 10: Future innovations that will make a killing in the stock market

Stocky 2 Comments

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All the stocks in the world add up to about $80 trillion.  I was surprised it was that low.  $80 trillion is definitely a lot of money, but for every publicly traded company in the world . . .

Interestingly, Microsoft, Google, Amazon, and Apple all have market caps of about $1 trillion.  That’s pretty astounding that a single company could be worth a trillion when all the companies combined are only worth $80 trillion.  It just shows you how big a really innovative company can get.

Second, look at that list—Microsoft, Google, Amazon, and Apple—either they didn’t exist not too long ago (Amazon, Google), or they did but what makes them valuable today are businesses that didn’t exist until relatively recently (Microsoft, Apple).

The point is that there are tremendous innovations that will come that will create tremendous value in the stock market.  As those four companies show, a single company with a powerful idea can really move the needle on the GLOBAL TOTAL.

Here is a list of 10 innovations that I think could easily create more trillion-dollar companies over the next few years.

10. Marijuana:  The past few years have seen a number of states legalize recreational marijuana.  I think it’s just a matter of time before it’s legalized nation-wide.

Right now the stocks of cigarette companies are worth about $700 billion.  The market capitalization for marijuana stocks is a tiny fraction of that.  Once the legal framework takes the brakes off marijuana companies, they are going to have a similar value.

In fact, it’s not unreasonable that marijuana stocks might be bigger than tobacco stocks.  Tobacco stocks are pariahs and they are constantly being harassed by different government agencies.  For what ever reasons, it seems the public is more accepting and embracing of marijuana compared to tobacco, so that removes a major headwind.

Second, there seem to be a lot more products that can be used with marijuana.  This is actually an area where Foxy Lady has been doing a lot of marketing consulting.  Obviously you can smoke it, but there’s also marijuana infused beverages, gummies, oils, and on and on.  It doesn’t seem like a stretch that marijuana could eclipse tobacco, and right now it is starting at pretty much $0.

9. Laboratory meat:  We just saw the IPO for a “fake meat” company.  The global meat market is a $1.5 trillion business annually. 

It’s also tremendously inefficient.  You have cows and chickens eating plants to “grow” the meat.  There’s a ton of pollution (cow farts, anyone?), slaughterhouses are disgusting, there’s the potential for nasty pathogens (hoof and mouth disease).  It’s just a messy, nasty, gross process.

If you can do that with grains and chemistry, you bypass all that.  Plus you use the land a lot more efficiently—you don’t need to grow plants to feed to cows which amass muscle; rather you just make the beef directly from the wheat and cut the cow out of the process.

Also, you can imagine that the process if you’re just dealing with tons of wheat and chemicals is much smoother than live animals and uniquely shaped carcasses.  This should certainly lead to lower prices per pound of meat while reducing tons of pollution.

8. Virtual reality:  VR has been the playground of science fiction nerds and more recently hard-core tech nerds, but it isn’t even close to the mainstream.  Today it mostly exists in the video game world, and even then it’s pretty marginalized.  VR games sell a tiny fraction of popular consul games, and even then the technology is still clunky.

Yet is there any question this will get better?  It seems a lot like cell phones from the 1980s.  Cool technology that just isn’t as good as the status quo, but it’s obvious to everyone that it will advance and once it does it will change the world.  That’s exactly what happened for cell phones, and I think that’s exactly what will happen with VR

Certainty the $160 billion video game industry will be transformed.  Movies and TV too.  But I think the real value will come from applications that people are just imagining right now.  Think of technical training—med school or pilots or the firefighters.  Think about the real estate industry and taking a tour of a home from your sofa.

The tech seems a few years away.  As that happens it will open up entire industries that we can’t even imagine today, just like cell phones did.

7.  Cure diabetes:  This one is near and dear to my heart (or rather my pancreas), after working for Medtronic Diabetes for so long.  Diabetes is a horrible disease.  Yet it’s very treatable and manageable.  Just monitor your blood sugar levels and treat accordingly (if your blood sugar is high, give yourself insulin).

Of course it’s never that easy.  Measuring isn’t always timely and precise.  Synthetic insulin doesn’t always work as well as your body’s own stuff.  And the biggest issue is diabetics aren’t always vigilant—it takes a tremendous amount of discipline to manage it properly and people sometimes let it slide.

Just in the US it costs about $250 billion annually to treat diabetes, and worldwide it’s probably about $750 billion.  Luckily, thanks to Medtronic and others, we are on the brink of curing this horrible disease.  Sensors are getting better, lasting longer and coming down in price.  Pumps are getting better and integrating better with the sensors so those together act more like a healthy person’s body.

As these treatments improve, you reduce the MAJOR costs of diabetes which usually results from not controlling it precisely enough.  You have ER visits, car accidents, blindness, amputations—Yikes.

6.  Sports gambling:  The Supreme Court opened the doors on this one two years ago, and now we’re all waiting to see how things unfold.  Revenue from US sports (college and pro) is probably about $100 billion.  Revenue from American casinos is about $50 billion.

With legal sports gambling, those two behemoths have the perfect baby.  Obviously right now there’s a huge black market that is coming into the legal fold.  Just being legal with expand the amount of sports betting by orders of magnitude.  As sports betting gets traction and becomes more accessible, with more locations or the holy grail—internet gambling—that will similarly increase the total betting total.

Add on to that the considerable synergies that sports betting brings to both sports revenue and casinos, this move seems like there’s easily a trillion dollars of incremental value compared to what exists today.

Here’s the first half of my Top 10 industries that will create trillion dollar companies that don’t exist today.  Again, remember that right now the value of all the world’s stocks is about $80 trillion.  So these 5 ideas could increase the pie almost 10% just on their own (and you haven’t seen the top 5 yet).

Come back Wednesday for the exciting conclusion to this list.

Why you should probably have more stocks and less bonds

Stocky Leave a comment
buried-money

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When I wrote my three ingredients post, a few of you commented that I was crazy to have so much of our portfolio in stocks and so little in bonds (less than 1% in bonds).  Did I have a death wish or something?  What if I told you that I think a ton of people are leaving  gobs of money on the table because they are investing too conservatively?  Tell me more, you say.

We know that you need to balance risk and return in our investments.  This is most clearly done when we choose our mix of stocks (more risky, higher average returns) and bonds (less risky, lower average returns).  As an investor gets older they want to shift their asset allocation towards less risky investments because their time horizon is shortening.  We all agree with this.  So where is this hidden pot of gold I’m talking about?

Let’s look at the example of Mr and Mrs Grizzly.  They are both 65 years old and entering retirement.  They worked hard over the years and socked away $1 million that will see them through their golden years.  They do some internet research and learn that a sensible asset allocation in retirement is 40% stocks and 60% bonds, so they invest $400k in stocks and $600k in bonds.  Knowing the long term average returns are 8% for stocks and 4% for bonds, they expect their $1 million nest egg to generate about $56,000 per year ($400k * 8% + $600k *4%) , knowing that some years it will be more and some years it will be less.   So far so good, right?

1 m

THEY ARE LEAVING MAYBE $20,000 PER YEAR ON THE TABLE.  That’s a ton of money.  How can this be?  They seem to be doing everything right.  The answer is they are being way too conservative with their asset allocation.  They shouldn’t be investing $600k in bonds and $400 in stocks; stocks should be a much higher percentage.

Waaaaiiiiiiiittttttttt!!!  But didn’t we agree that about 60% of their portfolio should be in less risky investments?  Yes, we did.  Are you confused yet?

Hidden cash

Here’s what I didn’t tell you.  Mr and Mrs Grizzly have other investments that act a lot like bonds that aren’t included in that $1 million.  Both Mr Grizzly and Mrs Grizzly are eligible for Social Security with their monthly payments being $2000 each.  If Mr Grizzly (age 65) went to a company like Fidelity and bought an annuity that paid him $2000 each month until he died (doesn’t that sound a lot like Social Security), that would cost about $450k.  So in a way, Mr Grizzly’s Social Security payments are acting like a $450k government bond (theoretically it would be more than $450k since the US government has a better credit rating than Fidelity).  And remember that Mrs Grizzly is getting similar payments, so as a couple they have about $900k worth of “bond-ish” investments.

Also, Mr and Mrs Grizzly own their home that they could probably sell for $300k.  They don’t plan on selling but if they ever needed to they could tap the equity in their home either by selling it or doing a reverse mortgage.  So in a way, their house is another savings account for $300k.

If you add that up, all the sudden the picture looks really different.  They have about $950k of Social Security benefits that have the safety of a government bond.  Plus they have that $300k equity in their house.  That’s $1.25 million right there.

Investing your portfolio

So now let’s bring this bad boy full circle.  Remember their $1 million nest egg they were looking to invest?  Look at that in the context of their Social Security and house.  Now their total “assets” are about $2.25 million.  If you believe that the Social Security and house kind of feel like a bond, just those by themselves account for 55% of their portfolio.  If on top of that if you invest 60% of their $1 million nest egg in bonds, they have over 80% of their money in bonds, and that seems way too high.

2 25 m a

On the other hand, let’s say they only put $100k of their nest egg into bonds and the rest into stocks, after you include their social security and home, they’d be at about 60% bonds and 40% stocks.  Isn’t that what they were aiming for the whole time?

2 25 m b

Wow.  It took a long time to get there, Stocky.  The punchline better be worth it.  Remember that with $600k in bonds and $400k in stocks, they had an expected return of about $56,000 per year.  However, if they have $100k in bonds and $900k in stocks, because stocks are more volatile but have a higher expected return, they can expect about $76,000 ($800k * 8% + $100k *4%).  THAT’S $20,000!!! 

But aren’t they taking on a lot more risk to get that extra $20k?  Remember, there’s no such thing as a free lunch.  For sure, but if you look at it in the context of their Social Security benefits and their home, they have a fair amount of cushion from “safe investments” to see them through any rough patches in the stock market.

I wrote this post to show that people really need to take account all the financial resources they have.  In the Grizzly’s case, it was their Social Security benefits and their home.  Others of you may be getting a pension (Medtronic is generous enough to offer the Fox family one) or a second home or a dozen other things like that.

When you take those cash flows into account, all the sudden it seems a lot more reasonable to invest the rest of your money a little more heavily in stocks which you know over the long haul will give you a better return.

The Fox family’s 2018 investment performance

Stocky Leave a comment

2018 was an “interesting” year for stocks.  Everyone wants to think “this one was different” but 2018 did seem to be pretty crazy. 

We had some wild swings pretty much the whole year: from January to December.  Going into December, I was marveling at what a genius I was with my prediction from the beginning of 2018 that the market would be up about 5% for the year.  Going into December it looked like I was going to be spot on . . . and then the bottom fell out of the market and you have where we are now.

Our stock performance

Just like most everyone else, we had a down year.  Of course, since we only invest in index mutual funds, by definition whatever the market did is the return we got.

Investment Ticker % of total portfolio 2018 return
US stocks VTSAX 50% -8%
Int stocks VTIAX 45% -18%
REITs VGSLX 5% -12%
TOTAL -12%

We were down 12%, and obviously that sucks, but . . .   There’s really no “but” so let’s not try to sugarcoat it, but maybe there is a silver lining.  Since the Great Recession in 2008, stock were up about 150% (about 11% annually) and had a 10 year winning streak. 

Dark blue was US stocks (down 8%) and light blue was International stocks (down 18%)

This year we had a down year, so it’s a bit hard to complain.  Historically, stocks are down for the year about 30% of the time.  We were probably due, so we shouldn’t get too greedy.  Still, it isn’t fun to go through a down market, but that’s life.

Notice any changes?

We also made a few simplifying changes to our portfolio starting in late 2017 and continuing into 2018.  At the end of 2017 we sold all our commodities as I discussed here.  In 2018, we also exited our Lending Club investment which was also a disappointment (although not nearly as bad as the commodities). 

That took us from five investments (US stock index fund, Int stock index fund, REIT fund, commodities ETF, and Lending Club) down to three.  If you remember the post on Three Investing Ingredients, I was getting closer to following my own advice.  The only thing still there was REITs.  In late 2018 we finally sold those off, so as of now, we are totally following the Three Investing Ingredients.  It’s nice to get back to basics.

At the beginning of 2020 when you read about how we did in 2019, there should only be two investments.

Inflation

The other thing I always look at at the end of the year is inflation.  US inflation came in at 2.4%.  It’s been inching up steadily over the past few years, and now it’s the highest it’s been since before the Great Recession.  Even so, 2.4% is still incredibly low.

We spend a ton of time talking about the impact inflation will have on your portfolio.  A few years back I even wrote almost a love note to the investing gods for 2015 being a no-inflation year.  The fact that inflation remains very tame compared to historical standards—I use 3% as a target for inflation—means we’re ahead of the game.

Wrapping it all up

Let’s chalk up 2019 to a crazy year and a “bad” year.  But we know sometimes we have bad years.  In the grand scheme of things it definitely could have been worse.

MY 2019 PREDICTION—I think our new normal for the next several years will be a lot of volatility, like we saw in 2018 and so far in 2019.  I never like trying to predict the stock market, but it just “feels” like we’re in for another down year.  I predict down 7%.  Of course I’ll use this as an opportunity to keep socking money away and buy stocks at prices that in 10 years will look bargains.

Light at the end of the tunnel for Bitcoin?

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Last year about this time, the nation was gripped in Bitcoin-mania.  It was dizzying.

As with most bubbles, it transcended financial markets and wormed its way into the mainstream. Everyone was talking about it, from late-night talk show hosts to grandmothers and everyone in between.

I wrote my thoughts on the matter here.  Just after that post, Bitcoin rose another 10% and then cratered precipitously.  I predicted its decline would result from it being connected to a terrorist attack and world governments using that as a pretext to extinguish it.  As it happened, it just seems that the bloom fell off Bitcoin’s rose.  Sometimes financial markets are fickle.

In 2017 Bitcoin rose from about $1000 to a peak of almost $20,000.  As fast as the rise was, the fall has been nearly as fast; from $20,000 to about $4000 today.  But this post isn’t a victory lap—Bitcoin bears were clearly proven right, so what’s the point of adding on there?

The point of this post is to give a little bit of love to Bitcoin.  I wouldn’t say I’m making a bullish bet on Bitcoin (I certainly haven’t bought any, and have no plans to).  However, here is an argument why it may not be doomed.

You can actually buy stuff

The biggest problem for Bitcoin was that it had no intrinsic value.  That’s not a deal-breaker: fiat currencies (dollars, euros, yuan, etc.) are only valuable because their home countries say they are and pass laws that you can use those pieces of paper to pay for stuff (more on this in a second). 

Without that government backing, Bitcoin becomes a bit like gold or diamonds, inherently worthless pieces of stuff but are valuable because enough people in the world think they are valuable.  Of course, a big difference is that you can hold gold or a diamond, but not so much with Bitcoin.

In December 2017 enough people thought Bitcoin had value that it pushed the price to $19,000. Today, many fewer think it is valuable so it’s worth much less, hence the $3400 price.

Through it all, Bitcoin was missing a major component of a currency (like a dollar) or even a store-of-value commodity (like gold)—you couldn’t buy anything with it.  I don’t think you would have had near the crash (and probably not the run-up either).

Until recently, you could only buy stuff with Bitcoin on the fringes of the economy.  Certainly, the black market accepted it, but that’s not exactly what we’re going for.  A very small handful of regular stores(virtual or brick-and-mortar) did, but that was minuscule.

That may be about to change in a profound way.  The state of Ohio recently announced that you can pay your taxes using Bitcoin. It’s hard to understate the importance of this.  Paying taxes, by definition, is about as legitimate a transaction as there is. All the sudden Bitcoin is a legitimate currency, at least to the state of Ohio.  To compound the point, I don’t believe you can pay your taxes in Ohio in euros or yuan (undeniably currencies)or gold or diamonds (undeniably stores of value).

How will this impact Bitcoin’s price

Now that Ohio will accept it, that will create a real market for Bitcoin.  That begs the question,what will that do to the price?  You should expect my normal answer: I have no idea. But I do have some thoughts.

Bitcoin’s price has been in freefall for months now.  This was caused in large part by the tiny, tiny issue of Bitcoin not being used anywhere. Now that has changed.  I still think Bitcoin could go down, but I definitely think it will not go down as much as it would have if Ohio hadn’t made it’s decision.  It’s impossible to know if I’m right or wrong on that, since we can’t test things in alternate dimensions.

It’s not to say Ohio is getting in the Bitcoin game.  It just takes the Bitcoin payments, sends them to a market to get exchanged into dollars, and they have their money.

Ohio has taken the first step and it’ll be interesting to see if any other states follow suit.  If a large state like New York, Texas, or California also starts accepting Bitcoin, I think that will definitely buoy it’s value as it becomes even more of an accepted currency.  And of course the coup d’etat would be the Federal government accepting it.

Overall, I still think Bitcoin will be volatile, probably to the downside.  However, I do think maybe we’ll back in five years when Bitcoin has settled to something of value,probably less than $4000, and look at this Ohio decision as the first step towards that stabilization.

First half of 2018—much ado about nothing

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I wanted to write a recap of the stock market in the first half of 2018.  It’s taken me a little while to get to it because I actually have a job that I’m working on.  Sorry about the delay, but here it is.

 

At first blush, you might think that the stock market has gone crazy.  I don’t know if you can objectively measure things, but it seems the media which has always been in a frenzy the past decade or so, has gone into overdrive lately.

Obviously there are the big rocks like: school shootings and gun control, the #metoo movement, the eternal Russia meddling probe, the North Korea talks, the retirement and impeding replacement of Justice Kennedy, and the separation of families of illegal immigrants.  There are probably more but those are top of mind.

Most of those are social issues, but they have major economic components.  The gun control debate will have a profound impact on gun manufacturers, many of whom are publicly traded.  #metoo has forced the resignation of several business leaders.  North Korea and Russia talks impact trade and possible war with mass destruction, which of course has a hugely negative impact on the economy.

And this misses the most exciting/depressing/entertaining news item (depending on your persuasion): President Trump.  He alone creates enough material to fill the 24-hour news cycle.

 

US Stock Market . . . happy yawn

So with all this, what has happened with the stock market.  Despite a few gyrations, it’s been fairly stable over a long-term point of view.  It had a  great January (continuing the really strong momentum from 2017), and then things peaked.

There are a few important takeaways.  First, there were a couple huge drops at the end of January and the end of March, but we recovered from those fairly steadily.  Second, we are now at where we were when the stock market peaked in January.  Third, remember that all this 2018 performance is coming on the heels of a spectacular 2017.

All things considered, that seems pretty good.  The market is up 4% so far for the year.  Maybe that seems a bit dissatisfying because it’s been flat since the peak in late January, but up is still up.  Let’s not look a gift horse in the mouth on this one.

 

International Stock Market . . . interesting

What I think is most interesting is that since May the US stock market has marched higher while international stocks markets have gone the other way.  Look at the chart for 2018 so far.

Most of the time, US (blue) and International (orange) stocks tend to move in sync.  Sure, there are always small differences, but by and large when one goes up the other does too and vice versa.  That was the story for sure for the first part of 2018.  Then something happened in May; since then US stocks have marched upwards about 6% while International stocks have fallen about 3%.  That’s a 9% difference!!!

I’ve racked my brain, and I don’t have a clear reason.  Sure, the North Korea situation continues to be goofy.  Italy elected an anti-immigration government that turned a boatload of refugees away.  Brexit unfolds like a car wreck in slow motion.  Syria, Russia, Venezuela—all the usual suspects.  But what has changed in the past couple months that has been so good for the US and so bad for the rest of the world?

The only thing I can really think of is the trade war Trump has initiated.  Typically in these there are winners and losers, so maybe the market is predicting that the US will “win” this and the rest of the world (especially the developing markets since those stocks are down the most) will “lose”.  There are a ton of complications and nuances and a million different things could happen, but that’s the best I could come up with.  I guess we all need to stay tuned.

Either way, what is going on right now with such a disparity in the performance of major stock indices is not common.

 

If you put that all into the pot and mix it, things have gone pretty well for the investor.  That seems a bit different from the constant news stories about how the world is on the brink of disaster, but that goes to show you that long-term investing washes away a lot of those shorter-term swings.

As always we are and have been fully invested in this stock market.

Federal reserve makes markets dive

Stocky 1 Comment

Nothing gets stock markets so excited as the Federal Reserve.  Here is a chart of the S&P 500 yesterday.  Quick, when do you think the Fed announced that it was going to raise interest rates?  Everything was going fine—it was a pretty smooth day and then at about 3pm the Fed made its decision and the bottom fell out of the stock market.  Why is the Fed so important?  What is it doing that can make a calm market move to much so quickly?

Basically (and this is very basic, as there is a boatload of nuisance in this) the Federal Reserve, and for that matter the central banks of any country, control the core interest rate.  That single, yet enormously powerful tool, allows the fed to influence the economy in a major way.

The guiding mission of the Fed is first and foremost to maintain a healthy level of inflation.  In the US that is around 2-3%.  Being too low has some problems that reasonable people can debate, but pretty much everyone believes that when inflation gets too high, that’s when really bad things happen.  So more than anything, the Fed is tasked with keeping inflation low.  Then a secondary goal is to promote a healthy and growing economy that keeps unemployment low.  So basically the Fed has two jobs, keep inflation low and keep the economy strong.

 

How does the Fed impact the economy?

Let’s imagine a really simple economy.  There are ten companies named A and B and C all the way down to J.  Just like in real-life, not all companies are created equal, with some being much more profitable than others.  Here A is the most profitable (maybe like Apple) while J is the least profitable (maybe like JC Penney).

Interest rates will play a big part in the profitability of these firms.  As interest rates go up, the amount they spend on interest for all their debt goes up as well.  Because A is so profitable, it would only start to lose money if interest rates went really high, up over 10%; however J is much more vulnerable and will become unprofitable if interest rates go over 1%.  All the other companies have a similar situation as shown in the graph.

So this is where the Fed comes in.  Let’s say the Fed sets the interest rate at 6%.  Firms A, B, C, D, and E are all profitable even when the interest rates are that high; but firms F, G, H, I, and J are not.  Because of that things won’t look good for firms F-J.  Maybe it’ll be so bad that they’ll go bankrupt or maybe they’ll lay off people or put a hiring freeze on.

At 6% interest, you have five firms that are doing well (A-E)—growing, hiring more people, expanding, etc.—and five that aren’t (F-J).  And at 6% the economy is performing at a certain level.  But what would happen if the Fed lowered the interest rate from 6% down to 5%?  One more firm (F) would be profitable, and in general it would benefit all the firms.  The profitable ones would be doing even better, and the unprofitable ones wouldn’t be quite so bad off.  And that would lead to a strong economy: more “stuff” would be produced and more people would be employed.

So there is very clear relationship that lower interest rates led to a stronger economy.  Having a strong economy is one of the Fed’s goals, so that begs the question, “Why doesn’t the Fed push rates all the way down to 0%?”

This is where it starts to get interesting.  It’s my favorite topic: Inflation.  Remember that the Fed’s first job is to control inflation.  Let’s look at the Fed’s decision to move interest rates from 6% to 5%, but now look at it with an eye towards inflation.

In our pretend world, let’s assume at 6% interest rates the economy is doing well.  Things are growing and unemployment is fairly low.  When interest rates go to 5%, firm F will become profitable so they’ll want to hire some people—makes sense.  But remember that unemployment is low, so F is going to need to tempt people who are already working for A or B or C or who ever to come work at F.  How does F do that?  They pay them more.

F starts to pay people more, but A doesn’t take this lying down, so A starts paying more.  This wage increase trickles through the economy.  But A and B and even F need to make money, so the increase in compensation they’re paying to their employees gets passed along to consumers in the form of higher prices.  When prices start rising, that’s INFLATION.  And controlling inflation is the Fed’s #1 goal.  So that creates the difficult balance for the Fed—they want the economy to do well but not so well that it triggers inflation.

So there you go.  You just completed a course in “Introductory Macroeconomics”.

 

What’s going on today?

Now that you have that little lesson under your belt, how does that relate to what’s going on with the Fed right now?  For the past couple years, the Fed has interest rates at historic lows, at about 0%.  Then about two years ago they started slowly raising interest rates to more normal levels, although even now the interest rates are still low by historical standards.  Obviously that’s super low, so shouldn’t the Fed be worried about inflation?

Remember the circumstances of how interest rates got that low.  At the beginning of 2008 the economy was going strong and the Fed interest rate was at over 5%.  But then the financial crisis hit, blowing up the banking industry, and sending the world economy into a very sharp recession.  A ton of people lost their jobs (unemployment went up) so prices stayed flat or even started to fall a little bit.

With all this going on, the Fed threw a life raft to the economy in the form of near 0% interest rates.  In the intervening years, the economy has rebounded and unemployment has fallen, but inflation has remained pleasantly low.  This is kind of the best of both worlds for the Fed—the economy is strong and there’s no inflation.  The two things they have to balance are both in happyland, so they have kept interest rates low.

 

What does it really mean when the Fed changes interest rates?

With all of this, are we just a bunch of idiots?  Should we really be so happy if the Fed is keeping rates low, and should we be so bummed if the Fed raises rates?

As the parent of two boys who one day may start sponging off Foxy Lady and me, I think the parent-child relationship is a good analogy.

Imagine you have parents (the Fed) who have a grown child (the US economy).  Times are tough for the child (the economy is doing poorly) so the parents help out (the Fed lowers interest rates).  The good scenario is that the child starts doing better to the point where he doesn’t need his parents’ help (the economy strengthens so it can withstand higher interest rates).  The bad scenario is the child becomes dependent on his parents’ help and is never able to make it on his own.

In this analogy the parents reducing the amount of help they give (the Fed raising rates) is a good thing, isn’t it?  It means that the kid is getting things on track and is standing on his two feet.  For this reason, I actually think it’s a good thing if the Fed raises interest rates because it means that the economy is strong enough that it doesn’t need insanely low interest rates any more.  Yet the markets react in the exact opposite direction.

I get it.  Just as the kid would be bummed if the parents said, “hey pal, since you’re starting to make some money now, we won’t be sending those monthly checks”, the companies are bummed that they can’t borrow money so cheaply.  But that isn’t sustainable.

I chalk this up to yet another of a million examples of how the stock market acts in a goofy manner in the short term.  And another reason why I NEVER try to time the market.  I just keep my head down and invest for the long term, regardless of what is going on with interest rates.  But watching everyone hang on Janet Yellen’s every last word does make for perverse entertainment.

 

As the current debate unfolds, what do you think?  Is the economy strong enough for the Fed to continue to take away the credit card?

BREXIT—when experts were idiots

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On June 23, 2016, the UK voted to leave the EU—Brexit.  The outcome of the vote was unexpected and EVERYONE freaked out.

As it turns out, nearly all those dire predictions were totally overstated.  A more objective view shows that the UK and the broader world are doing JUST FINE, probably even better than fine.  This is a good lesson that just because experts say something, especially in this world of 24-hour news cycles where crazy proclamations get the headlines, doesn’t mean they’re going to happen.

Brexit is a really good example were most experts, at least the loudest experts, got it totally wrong.

 

Let’s everyone totally freak out

The general consensus among mainstream media was this was an unmitigated disaster.  The imagery of UK self-inflicting a fatal wound was pervasive.

CNN described the impending “Brexit hangover” as though the British were a bunch of youngsters who did something immature and thoughtless like vote to leave the EU (or go out on a drinking binge).  In the light of day they would realize their error and suffer economically for their folly (hangover).

CNN also had the headline “Brexit + Deep Uncertainty = Market Chaos”.  The first line claims, “One of the foundations of the political world was thrown in disarray.”  The world in disarray????  Maybe a bit melodramatic on that one.

Magazines and newspapers had provocative headlines and covers.  The Economist called the vote “tragic”; the New York Daily News called it “foolish”; the New Yorker equated it to a suicidal leap off a cliff.  Let’s be serious for a second.

Even President Obama lent his voice to the echo-chamber chorus, warning Britians before the vote that Brexit would put them at “the back of the queue” when doing trade deals.  Clearly this was meant to scare British as a threat to their economy and livelihoods.

Making it more local, my Facebook feed was filled to the brim with dire Brexit predictions.  Nearly all these posts are from graduates of the University of Chicago’s business school.  These are people who have studied economics MUCH MORE than your average Joe.  Look at some of those comments.  Equating Brexit to World War II???   Really???

The point is Brexit was fairly universally acknowledged as a total disaster in the making by the loudest (but not necessarily the smartest) voices.  It’s easy, just based on the volume and frequency, to imagine there was something to that.  It’s been almost two years, so let’s look at what has actually happened to the UK since its citizens voted for Brexit.

 

Just the facts

For all the talk that Brexit was going to tilt the ENTIRE WORLD into financial disaster, let’s be real.  First, the UK isn’t that important.  It’s 21st in terms of population (a country with 0.9% of the world’s population), and it’s 6th in terms of GDP (3.4% of world’s GDP).  Let’s not overestimate the impact, ambiguous at best, that such a political move might have on the world.

In case your curious, the world’s GDP grew about 2.5% last year.  Equity markets are up about 25-30% since the vote happened.  That seems pretty darn good to me.

Looking at the UK in particular, it seems like things are going okay too.  There’s no totally objective way to assess the “strength of an economy”, especially among people whose political views predispose them to think one way or another.  That said there are some widely accepted metrics to look at.

 

UNEMPLOYMENT—UK unemployment since the vote has fallen pretty much in lockstep with the rest of the EU.  In June 2016 it was at 4.9%, and now it’s at about 4.3%.  That’s very slightly above Germany (widely regarded as the strongest economy in the EU), and much lower than the other major EU countries who have embraced EU-ism: France (9.2%), Italy (10.8%), and Spain (16.4).  VERDICT: not total disaster.

 

GDP GROWTH—UK GDP growth has been at about 0.4% quarterly since the vote.  That’s fairly middle of the road.  As usual, Germany’s metric is a bit better (0.6% growth), while France’s and Italy’s are in line (0.4-0.5%), Spain’s is higher (0.7%).

GDP growth is a very fickle metric in that it looks at changes, not absolute values.  Were Spain’s higher numbers because it is doing well now or that it was doing so poorly a few years back, and today’s number just look favorable compared to crappy numbers.  You can see the challenge.  Either way, it’s pretty clear that the UK isn’t performing at substantially worse level than the other major EU players.  VERDICT: not total disaster.

 

STOCK MARKET—The UK stock index (FTSE) is up about 20% since the vote.  That’s a bit less than the US (33%) and Europe (26%).  Maybe that’s evidence that the stock market thinks the UK made a mistake.  First, being up 20% definitely defies the idea that the UK is a disaster.

Second, just like GDP growth, there are a lot of factors that make it a bit challenging on how exactly to interpret it.  Right after the vote, the UK’s stock market well outperformed the others, and then it decelerated.  I chalk it up to general market gyrations.  VERDICT: not total disaster.

 

EXCHANGE RATE—After the Brexit vote, the exchange rate for the British Pound to the Euro fell from about 1.25 down to its current rate of 1.12.  Definitely you can see a clear move down.  Often times a depreciation in your exchange rate reflects negative circumstances for the country’s economy (see Venezuela).  Yet, that’s way too simplistic a view.  In the past year, the US dollar is down about 15% compared to the Euro, and I don’t think anyone seriously thinks the US economy is in a state of disaster compared to the European economy.

Also, if you look at the Pound/Euro exchange rate over a longer time period, the 1.15 range is actually where it has spent most of its time.  It was there in the early 2010s (when the UK was part of the EU), then it rose dramatically in 2015 when Greece’s drama unfolded as it nearly toppled the EU’s common currency (hmmmm . . . maybe that’s a reason why the British voted for Brexit).  Now it has fallen back to those previous levels.  VERDICT: not total disaster.

 

The point of all this is that it’s definitely not CLEAR that the UK’s Brexit vote was a total disaster.  Despite the incredibly smart people with a firm grasp of macroeconomics at CNN and the New Yorker among many, many others (I’m totally being sarcastic here—I think they’re idiots), just because they say something doesn’t mean it’s true.  They have the loudest voices in media today, but that doesn’t mean they have the smartest.  Remember, I am smarter than a Nobel Prize winner, and I do think Robert Schiller is really smart.

If you were Rip Van Winkle and slept through the last two years, and then upon waking were asked which Top 20 economy voted on an economic policy that was tantamount to “Tragically foolish suicide that pulled the world into chaos”, I’m not sure you’d zero in on the UK.  Actually, you’d think things look pretty good there, not nearly as horrible as that description would lead you to believe.

There’s a bit of a lesson here.  Keep this in mind when everyone in the media and on your Facebook feed starts talking about how obviously good or obviously bad something is.  Quick things that come to mind are: economic impact of Trump’s tariffs, inevitability of China overtaking the US in GDP, the impact/harm of the Trump tax cut.  These things are highly complex and very nuanced; rarely are they unambiguously good or bad in the manner that grabs headlines in our oversaturated media landscape today.  Don’t be a sucker.