Saturday, May 29, 2021

April Inflation

This week the Bureau of Economic Analysis reported April PCE (Personal Consumption Expenditures) excluding food and energy, the number rose 3.1%. This marks the first time this number has been over 3% since 1992. This is an economic number that the Federal Reserve watches closely as an indication of inflation at the consumer level. The Federal Reserve has communicated that as the world emerges from the pandemic, disruptions in supply chains will result in a transitory inflation spike. The Fed's position is that inflation will moderate with policy adjustments and the normalization of the economy. An indication of market participant's inflation concern is reflected in bond yields which were little changed on the news. The Federal Reserve has made it clear that its goal is to create inflation above 2% with a longer-term average of 2%. The reaction in the bond market suggests that, at least for now, market participants believe the Federal Reserve can keep inflation under control.


Currently, the Federal Reserve purchases $120B in bonds monthly, which is viewed as inflationary. Recently several Fed Presidents have suggested that recent economic data is strong enough to justify talking about a policy shift. I think the Fed will begin signaling its intent in the coming months to reduce its bond-buying program, and equity markets could have a short-term adjustment. I believe inflation fears are premature. We continue to have strong deflationary forces through the globalization of labor and manufacturing and increased productivity due to technology utilization. I would be concerned about a protracted period of rapid inflation; historically, that economic condition is corrected by a recession. As always, I will monitor the economic data and adjust accordingly.

Sunday, February 21, 2021

My View on Bitcoin

Video Podcast

Audio Podcast

Recently I've received many questions about Bitcoin and cryptocurrencies. The topic has become increasingly popular on news and social media. I've spent some time exploring the subject looking at it from a technological, economic, and social standpoint. Let me offer some insight, my opinion, and answer some of the most common questions. 

What is Bitcoin? Bitcoin is a digital unit of value. It is an encrypted text file stored on the Bitcoin blockchain. The Bitcoin blockchain is an encrypted, decentralized ledger on a global public computer network. That is as technical as I'm going to get. Let's focus on the idea of a ledger. When you deposit money in your checking account or write a check against the balance, your bank keeps records of the inflows and outflows on an account ledger on their computers, and it is denominated in dollars. But it is still just an encrypted text file that represents value. We trust that we can exchange the value represented by that text file at the bank for physical currency or transfer the value to others to buy goods and services.

When you buy Bitcoin, you are exchanging Dollars for a value denominated in Bitcoin recorded on multiple, identical ledgers on privately owned computers around the world on the Bitcoin blockchain network. The currency exchange is not unlike exchanging Dollars for Euro, Yen, or any other currency. The value of a currency is a function of the currency's supply and the demand for it by others. Most people buy another currency because they need to settle a transaction in that currency. If people in Europe want to buy US Bonds, they need to buy Dollars to complete that transaction. Or if a company in China buys equipment from a US company, they need to buy Dollars to settle the transaction. Unlike other currencies, there is no demand for Bitcoin for the settlement of foreign commerce. This eliminates a natural source of support that other forms of currency enjoy. 

Why does Bitcoin have value? The short answer is because people think it does. The value of anything is what someone else is willing to pay for it. From an academic standpoint, value is a function of utility and scarcity. The air we breathe has a lot of utility, but it's not particularly scarce, so it would be difficult to sell. If we are going scuba diving, we're willing to pay for air in a tank. The air has the same utility, but it's scarce where we're going. Bitcoin has technological scarcity as there is an absolute limit of 21M coins that will ever be created. The last Bitcoin will be created in 2140. From 2009 through 2020, 18M Bitcoin have been created, meaning only 3M more can be created. The limit of 21M coins theoretically gives Bitcoin scarcity. Bitcoin's utility is evolving. Some use it as a store of value. Some believe that it may be used as a medium of exchange as a cash alternative in the future. But its primary value is linked to its demand as a store of value.

Can the price of Bitcoin continue to rise? Absolutely! I have seen estimates as high as $146K per coin. However, Bitcoin is an unproductive asset. Unlike investing in a company's stock, it does not produce a product, have earnings, or pay a dividend, making it very hard to value. It is difficult to know if it is cheap or expensive. It is also impossible for it to disappoint investors by not meeting growth or earnings estimates, so it's difficult to anticipate the catalyst for a downturn. The only reasonable metric I've seen to estimate its price is a stock-to-flow ratio. Stock-to-flow models are used to evaluate the current inventory of a commodity, like gold, against the flow of new production available in a given year. Using a stock-to-flow, I would expect Bitcoin's price to rise in perpetuity; however, this model did not predict previous price declines. It can continue to rise in price as long as there is a collective belief that it will.

Is Bitcoin a currency? Technically No.

A currency is a medium of exchange that is generally accepted and used to pay taxes, debts and pay for goods and services.

·      Bitcoin is not yet generally accepted as payment.

·      There is no legal requirement to accept Bitcoin as payment for debt as exists for Dollars.

·      The IRS has determined that Bitcoin is a property for the purposes of taxation.

WWhy do people buy Bitcoin when we already have a currency?

I've identified five reasons some are choosing to trade their dollars for Bitcoin.

1.     The belief that they will be able to sell their Bitcoin to someone else at a higher price in the future. These are generally people who don't know much about Bitcoin other than it has recently gone up in price and see an opportunity to get rich quickly. This is referred to as "The Greater Fool Theory." This is the idea that regardless of the price, there will be a greater fool who will pay more than I did.

2.     The belief that the expansion of the money supply by global central banks will lead to the devaluation of the US Dollar and hyperinflation. Bitcoin is seen as a hedge against inflation and a falling dollar. These are people buying Bitcoin for its long-term economic potential. Because the quantity of Bitcoin is fixed, it is impossible to produce an unlimited amount as is possible with fiat currency. 

3.     The interest Cryptocurrencies rose out of the financial crisis in 08-09. Some feel that the government took on too much debt to bail out Wall Street firms and large banks, that banks take unnecessary risks with people’s money and can’t be trusted. Cryptocurrencies are seen as a path to taking control of money out of central governments' hands through the adoption of decentralized digital currencies. These are people investing in Bitcoin for ideological reasons.

4.     Cryptocurrencies like Bitcoin are applications that run on blockchain networks. Some believe that Blockchain networks are the next iteration of the internet. Developers and technology investors own cryptocurrencies as technology investments and fund their applications on blockchain networks with the native cryptocurrency.

5.     There have been businesses that have added Bitcoin to their balance sheets. Most are actively or planning to provide cryptocurrency financial services. A few have replaced a portion of their cash reserves with Bitcoin. It isn't clear if this trend will continue should interest rates rise. 

Is inflation a real concern? Inflation is the economic condition of rising retail prices or declining currency value. In the 1970's we experienced a period of hyperinflation in the US.  Some are concerned that the Federal Reserve's easy monetary policy will lead to a return of inflation. There have been warnings about rising inflation since the Federal Reserve began their quantitative easing policy in 2009. Despite a decade of interest rates near zero, rising government debt, and the Federal Reserve's balance sheet expansion, inflation has remained low. Historically easy monetary policy has provides liquidity for increased economic activity leading to increased demand. The increased demand would lead to a tighter labor market. The tightening labor market would lead to upward pressure on wages. Increased labor costs would be passed on to the consumer in the form of rising prices, creating inflation. One meaningful difference now is that Central Banks all over the world are following the same path. So, when we talk about a weak Dollar, you have to ask the question, "weak compared to what?" 

Why does the Federal Reserve have a 2% inflation target?

Wouldn't it be better if prices never went up?

The reality is we need some level of inflation to keep the economy moving forward. Inflation is why you buy something today, rather than waiting six months. The expectation is that things will gradually cost more in the future than they cost today, so we buy things we need today to avoid paying more for them tomorrow. The Federal Reserve has a dual mandate from Congress to maintain maximum employment and price stability. Currently, the Federal Reserve is focused on encouraging inflation and economic activity by keeping interest rates low and liquidity readily available.

Historically a driver of inflation has been increased labor costs following spikes in consumer demand. That hasn't been the case in recent years. There are currently two primary forces keeping inflation in check: globalization and lower labor demand due to increased productivity from technological advancements. 

Globalization – For decades, there has been an increasing trend for companies to transfer labor-intensive activities to places in the world where labor is less expensive. We may not like jobs being exported to other countries, but it has served to keep consumer prices lower.

Technological Advancement – COVID highlighted the role of technology in maximizing the productivity of labor. People can leverage technology to do more. In manufacturing, we've seen increased use of robotics. In retail, we've seen increased use of kiosks and mobile phone applications to complete functions that once required human labor. All of these incremental changes serve to reduce demand for labor and upward pressure on wages.

One would think that there is some amount of liquidity injection from the government and the Federal Reserve to generate inflation. Given the anticipated increase in consumer demand combined with the unprecedented amount of economic stimulus, I think we have the best chance of seeing some level of inflation.

Will Bitcoin replace the US Dollar? No. I am absolutely positive that will never happen.

1.     The US Government is not going to surrender control of the currency. There will be some that think that the government can't stop that from happening. They are wrong. At the beginning of the Great Depression, people began hoarding gold. This prevented the Federal Reserve from expanding the money supply to stimulate the economy. President Roosevelt signed an executive order which prohibited people from hoarding gold or silver coin or bullion or certificates, under penalty of $10,000 and/or up-to ten years of imprisonment. Americans were ordered to sell their gold to the US Govt. for a fixed price. Americans could not legally own more than 5 ounces of gold until President Ford repealed the executive order in 1974. The government does not have to ban Bitcoin to discourage its use. The Federal Reserve could issue regulations limiting regulated banks' holdings due to Bitcoins' volatile nature. Congress could change the tax rate on gains on cryptocurrencies making it less advantageous to hold. The SEC could choose to regulate cryptocurrencies as securities and treat crypto exchanges as securities exchanges. Increased regulation would increase the cost of buying and selling cryptocurrencies.

2.     Due to its fixed quantity, Bitcoin is deflationary, and its use as a primary currency would wreck the economy. We exchange our time for money. Anything can be used as money; rocks, shells, beads, and precious metals have all been used as money and stores of value. If what we hold as money or a store of value is appreciating at a rate faster than the goods and services we can buy, people are incented to save their money rather than spend it. A deflationary economy is the opposite of an inflationary economy. In deflation, prices are falling, and the currency is increasing in value. People begin to delay engaging in the economy under the assumption that their money will buy more later. As consumers reduce engagement with the economy, retail demand falls, the need for labor is reduced, and unemployment rises. There is less money earned with more unemployed people, and demand falls further, requiring fewer and fewer employees. Unless the deflationary forces are addressed, a recession is likely, and a depression is possible. 

Should you own Bitcoin?

I have not recommended anyone buy or sell Bitcoin. It is speculative and volatile. Its uses aren't clearly defined or proven. It has been banned in some countries, and others are considering banning or limiting its use. If you choose to invest in cryptocurrencies, you should take time to educate yourself about what you're buying and why. Buying anything just because it is going up in price is never a good idea. There is a risk that if the vaccine is successful and people begin reengaging with the economy, some may find a better use for their wealth rather than holding it in digital currency. Any weakness in the price could discourage holders who do not have a firm conviction, and a downward price cascade could ensue. This is, of course, just speculation on my part. I hope you found this helpful.

 

Saturday, February 13, 2021

Is Inflation Just Around the Corner?

 

Video Version

 

Podcast Version


The Bureau of Labor Statistics released the January Consumer Price Index (CPI) report this week. CPI is a measure of inflation at the consumer level. CPI rose1.4% year over year. I know, it's thrilling! It seems people either yawn at this number or don't believe it accurately reflects what's going on in the real world.

 

So, what is inflation, and why is it something we need to watch right now? Inflation is an increase in prices or a fall in the purchasing power of money. Some believe that Washington's response to the Financial crisis and actions by the Federal Reserve will be inflationary.  

 

Congress has charged The Federal Reserve (The Fed) to use monetary policy to maintain maximum employment and stable prices. The Fed has many financial tools to help it achieve these goals, most notably adjusting interest rates and controlling the money supply. The Federal Reserve has set a target inflation rate of 2% with the belief that 2% is the rate most likely to produce financial conditions to achieve its goals. Despite their accommodative interest rate policy and bond-buying programs, 2% inflation has been elusive. 

 

The market interpreted the recent CPI report of 1.4% as giving Congress and The Federal Reserve cover to move forward with the planned $1.9T economic relief plan. However, I think a more in-depth look at the data and the world around us may be telling a different story, and inflation may be just around the corner.

 

CPI is a combination of inflation rates from different categories of economic activity. When we look where inflation is and where it isn't, I see the potential for a rise in inflation in the coming months. Used car prices rose by 10% as people began traveling more by car than by airplane. We saw an increase in the cost of food, utilities, and most other economic categories. Those increases were offset by decreases in prices of Airfare, Gasoline, and Energy. These are areas that we would expect to see prices rise as more people are vaccinated and reengage with the economy.

 

Since the Financial Crisis in 2009, the Federal Reserve has kept interest rates low, expanded the money supply and its balance sheet to encourage economic growth in pursuit of its Congressional mandate. Historically there has been a direct correlation between an expansion of the money supply and CPI. As the country emerges from the slowdown caused by the Pandemic, the Federal Reserve may need to turn its attention to price stability should inflation quickly exceed its 2% target. However, after more than a decade of aggressive monetary policy inflation has remained tame. I'll be paying close attention to future reports. Should inflation begin to accelerate, we would want to position investment into the areas that would benefit from rising inflation.


Sunday, February 7, 2021

How to Avoid Online Romance Scams

Several months ago, I had the opportunity to attend a webinar put on by the National Cybersecurity Alliance. The topic was general cybersecurity practices for businesses. Periodically they send me information on other cybersecurity topics. Recently, they sent an email titled "How to Avoid Online Romance Scams." With Valentine's Day approaching, I thought this would be an excellent time to take a deeper dive into this topic.

According to the Federal Trade Commission, in 2019, online romance scams were the costliest category of any scam reported, with losses totaling over $200 million and the median individual loss being $10,000. And that's just the losses that were reported. We don’t have the 2020 numbers yet but I suspect the increased isolation brought on by the Pandemic has increased the number of victims and losses.

Many people find love online. Dating applications are some of the most frequently downloaded from app stores. Most people on online dating sites are good people sincerely looking for companionship. Just as we are aware when traveling that there are pickpockets, you should also be mindful that some people online are con-artists intent on stealing your money by pulling on your heartstrings.

Anyone, at any age, can be the victim of a romance scam; however, the most common demographic is divorced or widowed women over the age of 40. Scammers are predominantly men, and women over the age of 40 tend to have more wealth than their younger counterparts.

In a recent news report David McClellan, CEO of socialcatfish.com, said they interviewed a Nigerian scammer who revealed that about 1 in 10 people would give him some amount of money.
Here are some of the red flags that someone you've met online may be a scammer.
  •     They will not meet in person. They make plans to meet but repeatedly cancel. Even if they're not a scammer, don't invest yourself in people that don't value your time.
  • There is a fantastic story or drama that creates an emergency that leads to an urgent need for money. They may claim to need money to travel home or pay for medical expenses for themselves or a family member. Even if they're not a scammer, don't get involved with someone who has more problems than you do.
  • Scammers often claim to be a Doctor working for an international organization, work on an oil rig or be in the military.
    • The US Army receives hundreds of complaints per month from victims of online scams perpetrated by people claiming to be soldiers. These people will often claim financial hardship due to a lack of support from the military. This is a common ploy by con-artists to leverage a person's guilt in persuading someone to send money. 
  • The person sends you a picture of someone who looks like a supermodel. Unless you typically date supermodels, this should be a red flag.
  • They quickly declare their love for you. People don't typically fall in love with someone they've never met. Even if they're not a scammer, this could sign some mental or emotional issues.
  • He or she doesn't use good grammar or punctuation. Most scammers are not located in the United States, and English is not their primary language.
  • A scammer's social media accounts may have few photos with posting dates that are close together. They may have few followers and few comments on their posts.
What are some things you can do to protect yourself if you suspect you’re communicating with a romance scammer?

  • Stop communicating with the romance scammer.
  • Copy and paste the emails and text messages into a search engine. There are websites that collect these message templates. You may find the same message has been sent to thousands of others.
  • Do not send money to anyone you don’t know. If you wouldn’t loan someone your car you shouldn’t give them money.
  • Don’t send pictures to a stranger that aren’t already on your social media profile. Scammers have been known to blackmail people after asking for revealing photos.
  • Trust yourself. Trust your gut. Trust your instincts. If something doesn’t feel comfortable there may be good reason.
 
If you have been a victim of a romance scam, say something.
 
If you gave someone your bank or credit card information, contact the card issuer immediately.
 
File a complaint with the FBI Internet Crime Complaint Center
https://www.ic3.gov
 
File a fraud report with the Federal Trade Commission
https://ftc.gov/cmoplaint
 
Social Media platforms have methods to report imposters profiles.
Facebook – On the persons profiles there is a three-dot menu. Go to the Find Support or Report Profile option and report the profile.

Twitter - https://help.twitter.com/en/forms/authenticity/impersonation

Instagram - https://help.instagram.com/contact/636276399721841
 
Amazon Gift Card - If you gave someone the number from an Amazon Gift Card, keep the card itself and your receipt and call 888-280-4331 or go to:
https://www.amazon.com/giftcardscams/b?ie=UTF8&node=15435487011
 
Ebay Gift Card - If you gave someone the number from an Ebay Gift Card, keep the card itself and your receipt and call 866-305-3229 or go to:
https://www.ebay.com/help/buying/paying-items/ebay-gift-cards?id=4640#section4
 
Google Play - If you gave someone the number from a Google Play Gift Card, keep the card itself and your receipt and call 855-466-4438 or go to:
https://support.google.com/googleplay/answer/9057338?hl=en&ref_topic=9057343
 
iTunes - If you gave someone the number from an iTunes Gift Card, keep the card itself and your receipt and call 800-275-2273 or go to:
https://support.apple.com/itunes-gift-card-scams

Friday, December 25, 2020

The Georgia Senate Run-Off May Matter Less Than Some Think

 YouTube Video Version

 

In the 2021 Outlook, I discussed the coming run-off election for the two Georgia Senate seats. In the outlook, I said equity markets tend to do better under a divided government than when one party controls both houses of Congress. Equity markets seem to be proceeding under the assumption that Republicans will retain control of the Senate, and we will continue with a divided government. I've had a couple of questions asking how the economy and markets would respond if Democrats took control of the Senate.

 

The nation continues to be divided across political and ideological lines. Everything seems to be seen through a partisan lens. However, the Senate is considered to be a more deliberative and moderate legislative body. Currently, Republicans hold 50 of the 100 Senate seats, Democrats 48, and the remaining two will be decided by a run-off election to be held on January 5th. Were Democrats to win both of the run-off elections, they would gain control of the Senate when Vice-President Elect Kamala Harris takes office. The Vice-President serves as the President of the Senate and may vote to break a tie. Some are assuming that if Democrats win control of the Senate, we could expect a radical change in tax policy and other government regulations. There are rumors that Democrats will move to expand the number of Justices on the Supreme Court and add left-leaning justices. There are rumors that Democrats will seek to end the filibuster, minimizing legislative debate.

 

Unlike the House of Representatives, Senators don't always vote along party lines. On November 9th, 2020, Sen. Joe Manchin (D-WV) posted his comments from a Fox News interview on his Twitter account; "Let me be clear: I will not vote to pack the courts & I will not vote to end the filibuster. The U.S. Senate is the most deliberative body in the world. It was made so that we work together in a bipartisan way. If you get rid of the filibuster, there's no reason to have a Senate."

Joe Manchin's - Twitter Post

 

Govtrack.us gives legislators an Ideology Score based on bills that they sponsor, co-sponsors, and voting records. The score can be used as a left-right scale. The 2019 Score Card ranked Sen. Kyrsten Sinema (D-AZ) as the most conservative Democrat in the Senate, more conservative than both Sen. Rand Paul [R-KY] and Majority Leader Sen. Mitch McConnell [R-KY].

Govtrack 2019 Senate Ideology Score

 

If Democrats take control of the Senate, markets may have a short period of volatility as market participants reposition some investments. But I do not believe it would necessarily signal a radical legislative agenda.

Sunday, December 13, 2020

The Roaring 20’s

The Roaring 20's
2021 Outlook 

In school, we were taught that the economic expansion known as the “Roaring 20’s” was ushered in by the end of World War I in 1918. Maybe that wasn’t the whole story. Maybe the pent-up demand of a nation that had been locked down during the Spanish Flu of 1918 & 1919 played a more significant role than we once thought.

 

So far this month I’ve reviewed more than a dozen economic and market outlooks for the coming year. The range of expected outcomes ranges from a double-dip recession to equity market returns of 20%. There are always things to worry about. It is said that markets climb a wall of worry. But I believe that 2021 could be a good year for the economy and markets provided a few issues resolve favorably.


The Summary

The economic data supports the outlook that the economy will expand and markets will rise in 2021. The consumer has significant savings, increased access to credit, and pent-up demand for traveling, spending, and engaging in the economy. The Federal Reserve has stated that monetary policy will remain accommodative and inflation remains under control. The Federal Government is expected to provide additional fiscal support. Although there are never economic or market guarantees, the current economic conditions support expansion.

The outlook is based on some assumptions.
  • The vaccine will be distributed with minimal disruption and will be effective.
  • The vaccine will be available to everyone who wants it in the 2nd.
  • Republicans retain control of the Senate.
  • Consumer spending increases in the 2nd half of next year.

 

The Positives

From a financial standpoint, the Pandemic has not impacted everyone equally. Our local small businesses are essential to the fabric of our communities, they have been hit harder than larger national chains, but their stock isn’t traded on equity markets, so their struggles have not been a drag on the rising stock market. Those who work in the service sector, retail, travel, leisure, and entertainment have also been hit hard. We can’t lose sight of the fact that the Pandemic has caused real financial hardships for people. However, many people have continued working either remotely or socially distanced. Those who have been able to work remotely tend to be more highly paid workers and are responsible for a larger portion of consumer spending.

 

Congress has provided several financial aid packages, and all indications are that there are more to come. To better understand why the economy and equity markets may continue to grow next year, we need to look at what Americans have done with their money during the Pandemic and current economic data.


  • We’ve seen a spike in the personal savings rate. According to the Federal Reserve Bank of St. Louis, the current personal savings rate is 13.6%, following a spike to 33.7% in April. This is the highest personal savings rate since 1975.
  • According to FICO, the average American’s credit score is 711, a 15 year high.
  • The rising stock market and rising home values are creating a wealth effect. A report from the Federal Reserve showed Americans’ household net worth hit a record $123.5T in the third quarter
  • As measured by the Consumer Price Index, reported by the Bureau of Labor Statistics, inflation is running at a low 1.7%, still below the Federal Reserve’s target of 2%. 

Equity markets are forward-looking. Market participants anticipate where the economy will be in six to twelve months rather than responding to current conditions. Higher levels of unemployment and local lockdowns will be a drag on the economy in the near-term, and unemployment may rise through the Winter. Still, these conditions are expected to be temporary, and markets tend to look through transient events.

 

The Challenges

Much of the political uncertainty that has been hanging over markets for the past year has been resolved. The run-off races in January will bring this political season to a close. Markets appear to have priced in that Republicans will retain control of the Senate. Markets perform best under a divided government where significant changes are less likely and take longer to occur.  If Republicans do not maintain control of the Senate, I expect a period of increased market volatility as market participants reposition their investments. Democrat control of Congress may mean higher taxes but could also mean larger stimulus packages.

 

The Pandemic brought our economy to a halt. The success of the vaccine’s distribution, efficacy, and adoption is critical if we are to see a return to normal economic activity.

 

 It isn’t clear how many of the jobs lost during the Pandemic are permanent and how many will come back as the number of cases falls and more people reengage with the economy. A rise in unemployment is expected through the Winter months improving as we move into the Spring.

 

In recent years there has been increasing friction regarding international trade. We aren’t sure what future trade policy might look like or its impact on the economy.

 

Additional government support is needed to bridge the economy until the Pandemic has passed. If Congress fails to deliver the necessary support, risks to the economy grow.

 

Equity markets are expensive on a Price to Earnings basis. According to the Wall Street Journal, the S&P 500 is currently trading at 41.52 times trailing earnings and 25.85 times forward earnings. These levels are at historically higher levels due to the low yields in fixed-income investments. If earnings disappoint next year, estimates for market returns may need to come down.

 

There are always positives and negatives to consider when investing. Conditions can change, and ongoing monitoring is needed to evaluate needed changes. Please call me with any questions or concerns.



Disclosures

The opinions, statements, and forecasts presented herein are general information only and are not intended to provide specific investment advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, please consult your financial professional before investing. 

Any forward-looking statements, including the economic forecasts, may not develop as predicted and are subject to change based on future market and other conditions. All performance referenced is historical and is no guarantee of future results. 

All information is believed to be from reliable sources; however, Rhino Wealth Management, Inc. makes no representation as to its completeness or accuracy. 

Investing involves risks, including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments. Diversification does not protect against market risk. Investing in foreign and emerging markets, debt or securities involves unique additional risks. These risks include, but are not limited to, currency risk, geopolitical risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks.

Gross domestic product (GDP) is the monetary value of all the finished goods and services produced within a country’s borders in a specific period. However, GDP is usually calculated on an annual basis. It includes private and public consumption, government outlays investments and exports less imports within a defined territory. 

The PE ratio (price-to-earnings ratio) is a measure of the price paid for a share relative to the firm’s annual net income or profit per share. It is a financial ratio used for valuation: a higher PE ratio means that investors pay more for each unit of net income, so the stock is more expensive than one with a lower PE ratio. 

Earnings per share (EPS) is the portion of a company’s profit allocated to each outstanding share of common stock. EPS serves as an indicator of a company’s profitability. Earnings per share is generally considered to be the most critical variable in determining a share’s price. It is also a major component used to calculate the price-to-earnings valuation ratio. 

The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. 

Investing in stock includes numerous specific risks, including the fluctuation of dividend, loss of principal, and potential illiquidity of the investment in a falling market. Because of their narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies. 

 


Sunday, August 2, 2020

Small-Caps, Mid-Caps, and Large Caps. What are they and why does it matter?

You may have seen the terms large-cap, mid-cap, or small-cap on an investment statement or a list of available investment options through an employer’s retirement plan. The term “cap” refers to a company’s market capitalization. That is the value of all the outstanding shares of the company’s stock. A small-cap is a company with a market capitalization of between $300 million and $2 billion. Although $300 million to $2 billion is a lot of money, most small-cap companies aren’t household names. A mid-cap company is one with a market capitalization of between $2 billion and $10 billion. Here you will find companies that many have heard of, but whose products or services are used less frequently or by a limited number of people. Above $10 billion is where we find the large-cap companies. These are generally household names. You would recognize the names of most of these companies, and many people regularly use their products or services. There are also less often used terms, mega-cap, and micro-cap. Mega-cap refers to companies with a market capitalization of over $200 billion. Micro-cap describes companies whose stock may be publicly traded but whose market capitalization falls below $300 million.

 

Market capitalization contributes to the risk, reward, and role of an investment in a portfolio. Smaller companies may not have the resources of larger companies and are more likely to struggle during periods of economic uncertainty. During periods of economic growth, it is easier for a smaller company to grow on a percentage basis than it would be for a larger company. Low-interest rates can provide favorable conditions for smaller companies to grow, as a smaller percentage of their revenue is allocated to debt service. In contrast, larger companies usually have more access to capital and are often considered to be a better credit risk. Understanding the role market capitalization plays in a portfolio can improve investment selection, portfolio construction, and may lead to better investment outcomes.

Wednesday, July 22, 2020

Are We in A Bubble?

Are We in A Bubble?

 

Today some are comparing the rise in Technology stocks to a bubble. Are we in a bubble? In 2000, I was a business student at Clemson University. I recall sitting in a grocery store parking lot, listening to a business news report. This was before we had market news and the internet on our cell phones. I don’t recall the name of the company being discussed, but some of the numbers caught my attention. I quickly grabbed my financial calculator and found that the company’s stock price was more than 100 times its expected earnings for the next year (the historical average is about 16 or 17). The company had a web address but didn’t even have a building. We now refer to this period as the Dot Com Bubble.

 

What is a bubble?

 

A bubble is an increase in asset prices to levels that aren’t justified by conventional methods of valuation, followed by a rapid contraction. Economists have identified five stages of a bubble.

 

1.     Displacement – This is a period where investors are initially attracted to a concept or the idea of something tied to an asset. We saw this during the Dot Com Bubble, where investors fell in love with any company with Dot Com in their name. Following the Dot Com Bubble, there was a sharp decline in mortgage rates that eventually led to the Housing Bubble.

2.     Boom – Excitement gains momentum, and prices begin to rise. The Fear of Missing Out sets in, and more investors are attracted. Media attention fuels widespread interest as prices continue moving higher.

3.     Euphoria – At this stage, investors’ enthusiasm for the investment theme reaches a fever pitch. There seems to be no price too high as described by the “greater fool” theory suggesting there will always be someone who will buy the asset at a yet higher price.

4.     Profit Taking – There comes the point when some investors recognize the bubble, believe it’s about to pop, and are willing to sell. Trying to time this phase is a fool’s errand. As economist John Maynard Keynes said, “the markets can stay irrational longer than you can stay solvent.”

5.     Panic – As the selling begins, prices start to fall, and investors all run for the same exit door at the same time. Panic selling exacerbates the price decline, and the bubble pops.

 

The first recorded economic bubble, known as “Tulip Mania,” occurred in the Netherlands between 1636-1637. During this period, the Dutch Republic was an economic and financial superpower. Tulips were considered a luxury and a sign of wealth. Owning Tulip bulbs became a status symbol, and the prices of various varieties began to rise. At the peak of frenzied buying, a single Tulip bulb could cost ten times an average worker’s annual salary or as much as a house. As quickly as it started, in February of 1637, Tulip prices plummeted, and fortunes were lost. Today we recognize that the prices paid for Tulips during the Tulip Mania were outrageous. At the time, many investors thought the prices were quite reasonable. Tulip Mania demonstrates how difficult it can be to recognize a bubble during a period of euphoria.

 

“History Doesn’t Repeat Itself, but It Often Rhymes” – Mark Twain.

 

I don’t think we’ll see a repeat of the Dot Com Bubble. Lightning rarely strikes twice in the same place. Today technology is an intricate part of our lives and the global economy. Unlike 2000 most of the companies in the technology sector are real businesses with real revenue and actual earnings. The issue is that much of recent market gains have been narrowly concentrated in just a handful of technology companies. It’s yet to be seen if earnings will rise to justify current valuations. At some point, fundamentals always matter. Having an investment strategy based on economic fundamentals and reasonable valuations will help an investor avoid being caught in a bubble when it pops.

 

A video companion can be found at https://youtu.be/IuhlRS9dVYw