It’s bad enough to initially depend on just one source of income, but it’s even worse to not invest it or diversify it such that you protect it over time. In other words, there is more than one way to diversify your income.
(1) You can diversify your sources of income so that you have, say, two or three jobs
(2) You can diversify the ways in which you earn income
It’s better to go with the second option, even though, strictly speaking, it can be considered a version of the first.
You can work three jobs if you want. That will definitely give you three different sources of income. If you get laid off at one place, you’ll still have the other two jobs. It’s great to keep your options open, after all. Maybe you’re moving up at one place and you want to give it some time.
But working three jobs is really no different than just working more hours at the same job. You’re still a rat running on the wheel – just a bigger wheel, and you’re running faster, or for a longer period of time, and you get a bigger piece of cheese to take home.
What you really need to do is slowly outsource your own income stream.
Progressively safer streams of income
1. Invest in high yielding dividend stocks that grow their dividends yearly.
2. Reinvest a portion of the dividends into more high-yield stocks.
3. Use the other portion to pay current bills (and debt servicing if you have it)
4. Repeat by reinvesting proceeds into a different asset class: real estate with cashflow.
5. Repeat by reinvesting remainder of RE cashflow into another class: a business of your own, for example.
You may want to change the exact order and the benchmarks at which you would buy an investment property, for example, but the idea is generally the same. Protect your investment income by diverting it into different asset classes with (ideally) less risk.
Your day job is the most risky form of income. Not only do you have just one, but you have to pay with your time and energy just to get a return. You need to take that most highest level of risky income and lock it in to less risky streams, like dividends. I think these are actually less risky than starting a business on the side, because that’s just going to take up more of your precious energy in the beginning. Some can do it – for various reasons. I think starting a business is an excellent idea, but I think you can get more leverage in the beginning with juicy dividend growers.
On this model, the more that your day job kills you, the more you should try to save as much of that money as possible and convert it into another, less taxing, source of income. Do the same with your high-yield stocks. Precisely because they are high-yield (especially if the payout ratio is high, or they’re high yielding because of a recent price drop), you’ll want to redirect those dividends into forms of money with less velocity, like the money market or a bond fund. Then I’d get out of the corporate sphere altogether and create my own source of cashflow by buying an investment property and renting it out.
If you have enough income right now, perhaps you can skip these steps and just purchase your rental property right away. But the idea is the same. Recycle that money into a system that can be set on automatic, but wherein your money cycles through progressively lower levels of risk (you can do the work to determine the order of risk for each opportunity). Once that’s done you can focus on how to increase it the velocity of these cycles of money
Sunday, November 14, 2010
Friday, November 5, 2010
the bottom line on money printing
So, here’s the bottom line on money printing, or QE if you prefer. If nothing happens, the whole thing was a waste of time. If inflation takes off, the Fed will have to choose between holding bonds and letting inflation get worse or selling bonds and going bankrupt in the process. Since no entity goes down without a fight, the Fed will naturally hold the bonds and let inflation take off. Do not ask about the exit strategy from QE; there is no exit.
Sunday, September 19, 2010
Do you need to build a portfolio that will generate cash?
Are you more concerned with paying your bills and having enough income than growing richer?
If so, you need to focus on something called income investing.
This long-lost practice used to be popular before the great twenty-year bull market taught everyone to believe that the only good investment was one that you bought for ten dollars and sold for twenty.
Although income investing went out of style with the general public, the discipline is still quietly practiced throughout the mahogany paneled offices of the most respected wealth management firms in the world.
If so, you need to focus on something called income investing.
This long-lost practice used to be popular before the great twenty-year bull market taught everyone to believe that the only good investment was one that you bought for ten dollars and sold for twenty.
Although income investing went out of style with the general public, the discipline is still quietly practiced throughout the mahogany paneled offices of the most respected wealth management firms in the world.
Saturday, September 18, 2010
The Root of All Evil
Is the love of money the root of all evil? Or, is it the ignorance of money?
What did you learn about money in school? Have you ever wondered why our school systems do not teach us much—if anything—about money?
Is the lack of financial education in our schools simply an oversight by our educational leaders?
Or is it part of a larger conspiracy?
Regardless, whether we are rich or poor, educated or uneducated, child or adult, retired or working, we all use money.
Like it or not, money has a tremendous impact on our lives in today's world.
At investingforincome.com we believe that all can live a properous life if we just save and invest in income producing assets.
What did you learn about money in school? Have you ever wondered why our school systems do not teach us much—if anything—about money?
Is the lack of financial education in our schools simply an oversight by our educational leaders?
Or is it part of a larger conspiracy?
Regardless, whether we are rich or poor, educated or uneducated, child or adult, retired or working, we all use money.
Like it or not, money has a tremendous impact on our lives in today's world.
At investingforincome.com we believe that all can live a properous life if we just save and invest in income producing assets.
Monday, September 13, 2010
Fundamentals are Not the Fundamentals
If it is, then, primarily newly printed money flowing into and pushing up the prices of stocks and other assets, what real importance do the so-called fundamentals — revenues, earnings, cash flow, etc. — have? In the case of the fundamentals, too, it is newly printed money from the central bank, for the most part, that impacts these variables in the aggregate: the financial fundamentals are determined to a large degree by economic changes.
For example, revenues and, particularly, profits, rise and fall with the ebb and flow of money and spending that arises from central-bank credit creation. When the government creates new money and inserts it into the economy, the new money increases sales revenues of companies before it increases their costs; when sales revenues rise faster than costs, profit margins increase.
Specifically, how this comes about is that new money, created electronically by the government and loaned out through banks, is spent by borrowing companies.[7] Their expenditures show up as new and additional sales revenues for businesses. But much of the corresponding costs associated with the new revenues lags behind in time because of technical accounting procedures, such as the spreading of asset costs across the useful life of the asset (depreciation) and the postponing of recognition of inventory costs until the product is sold (cost of goods sold). These practices delay the recognition of costs on the profit-and-nloss statements (i.e., income statements).
Since these costs are recognized on companies' income statements months or years after they are actually incurred, their monetary value is diminished by inflation by the time they are recognized. For example, if a company recognizes $1 million in costs for equipment purchased in 1999, that $1 million is worth less today than in 1999; but on the income statement the corresponding revenues recognized today are in today's purchasing power. Therefore, there is an equivalently greater amount of revenues spent today for the same items than there was ten years ago (since it takes more money to buy the same good, due to the devaluation of the currency).
"With more money being created through time, the amount of revenues is always greater than the amount of costs, since most costs are incurred when there is less money existing."
Another way of looking at it is that, with more money being created through time, the amount of revenues is always greater than the amount of costs, since most costs are incurred when there is less money existing. Thus, because of inflation, the total monetary value of business costs in a given time frame is smaller than the total monetary value of the corresponding business revenues. Were there no inflation, costs would more closely equal revenues, even if their recognition were delayed.
In summary, credit expansion increases the spreads between revenue and costs, increasing profit margins. The tremendous amount of money created in 2008 and 2009 is what is responsible for the fantastic profits companies are currently reporting (even though the amount of money loaned out was small, relative to the increase in the monetary base).
Since business sales revenues increase before business costs, with every round of new money printed, business profit margins stay widened; they also increase in line with an increased rate of inflation. This is one reason why countries with high rates of inflation have such high rates of profit.[8] During bad economic times, when the government has quit printing money at a high rate, profits shrink, and during times of deflation, sales revenues fall faster than do costs.
It is also new money flowing into industry from the central bank that is the primary cause behind positive changes in leading economic indicators such as industrial production, consumer durables spending, and retail sales. As new money is created, these variables rise based on the new monetary demand, not because of resumed real economic growth.
A final example of money affecting the fundamentals is interest rates. It is said that when interest rates fall, the common method of discounting future expected cash flows with market interest rates means that the stock market should rise, since future earnings should be valued more highly. This is true both logically and mathematically. But, in the aggregate, if there is no more money with which to bid up stock prices, it is difficult for prices to rise, unless the interest rate declined due to an increase in savings rates.
In reality, the help needed to lift the market comes from the fact that when interest rates are lowered, it is by way of the central bank creating new money that hits the loanable-funds markets. This increases the supply of loanable funds and thus lowers rates. It is this new money being inserted into the market that then helps propel it higher.
(I would personally argue that most of the discounting of future values [PV calculations] demonstrated in finance textbooks and undertaken on Wall Street are misconceived as well. In a world of a constant money supply and falling prices, the future monetary value of the income of the average company would be about the same as the present value. Future values would hardly need to be discounted for time preference [and mathematically, it would not make sense], since lower consumer prices in the future would address this. Though investment analysts believe they should discount future values, I believe that they should not. What they should instead be discounting is earnings inflation and asset inflation, each of which grows at different paces.)
Excerpt From Ludwig Von Mises Institute
For example, revenues and, particularly, profits, rise and fall with the ebb and flow of money and spending that arises from central-bank credit creation. When the government creates new money and inserts it into the economy, the new money increases sales revenues of companies before it increases their costs; when sales revenues rise faster than costs, profit margins increase.
Specifically, how this comes about is that new money, created electronically by the government and loaned out through banks, is spent by borrowing companies.[7] Their expenditures show up as new and additional sales revenues for businesses. But much of the corresponding costs associated with the new revenues lags behind in time because of technical accounting procedures, such as the spreading of asset costs across the useful life of the asset (depreciation) and the postponing of recognition of inventory costs until the product is sold (cost of goods sold). These practices delay the recognition of costs on the profit-and-nloss statements (i.e., income statements).
Since these costs are recognized on companies' income statements months or years after they are actually incurred, their monetary value is diminished by inflation by the time they are recognized. For example, if a company recognizes $1 million in costs for equipment purchased in 1999, that $1 million is worth less today than in 1999; but on the income statement the corresponding revenues recognized today are in today's purchasing power. Therefore, there is an equivalently greater amount of revenues spent today for the same items than there was ten years ago (since it takes more money to buy the same good, due to the devaluation of the currency).
"With more money being created through time, the amount of revenues is always greater than the amount of costs, since most costs are incurred when there is less money existing."
Another way of looking at it is that, with more money being created through time, the amount of revenues is always greater than the amount of costs, since most costs are incurred when there is less money existing. Thus, because of inflation, the total monetary value of business costs in a given time frame is smaller than the total monetary value of the corresponding business revenues. Were there no inflation, costs would more closely equal revenues, even if their recognition were delayed.
In summary, credit expansion increases the spreads between revenue and costs, increasing profit margins. The tremendous amount of money created in 2008 and 2009 is what is responsible for the fantastic profits companies are currently reporting (even though the amount of money loaned out was small, relative to the increase in the monetary base).
Since business sales revenues increase before business costs, with every round of new money printed, business profit margins stay widened; they also increase in line with an increased rate of inflation. This is one reason why countries with high rates of inflation have such high rates of profit.[8] During bad economic times, when the government has quit printing money at a high rate, profits shrink, and during times of deflation, sales revenues fall faster than do costs.
It is also new money flowing into industry from the central bank that is the primary cause behind positive changes in leading economic indicators such as industrial production, consumer durables spending, and retail sales. As new money is created, these variables rise based on the new monetary demand, not because of resumed real economic growth.
A final example of money affecting the fundamentals is interest rates. It is said that when interest rates fall, the common method of discounting future expected cash flows with market interest rates means that the stock market should rise, since future earnings should be valued more highly. This is true both logically and mathematically. But, in the aggregate, if there is no more money with which to bid up stock prices, it is difficult for prices to rise, unless the interest rate declined due to an increase in savings rates.
In reality, the help needed to lift the market comes from the fact that when interest rates are lowered, it is by way of the central bank creating new money that hits the loanable-funds markets. This increases the supply of loanable funds and thus lowers rates. It is this new money being inserted into the market that then helps propel it higher.
(I would personally argue that most of the discounting of future values [PV calculations] demonstrated in finance textbooks and undertaken on Wall Street are misconceived as well. In a world of a constant money supply and falling prices, the future monetary value of the income of the average company would be about the same as the present value. Future values would hardly need to be discounted for time preference [and mathematically, it would not make sense], since lower consumer prices in the future would address this. Though investment analysts believe they should discount future values, I believe that they should not. What they should instead be discounting is earnings inflation and asset inflation, each of which grows at different paces.)
Excerpt From Ludwig Von Mises Institute
Sunday, September 12, 2010
Who Should Manage Your Money? Only You!
The typical stockbroker went from selling shoes or cars to hustling stocks after passing the exam.
Your financial future is not his or her concern; generating sales commissions is. Of course there is plenty of free advice out there, from Jim Cramer to Suze Orman. But, you will likely get what you pay for.
Finding good investments is very hard work. Buying them at the right price is even harder work. Having the patience to buy at the right time and sell at the right time is nearly impossible.
Your best bet is to invest in companies that pay monthly distributions. At least this way you get paid to ride things out or to recover your capital if your investment was poorly timed.
Your financial future is not his or her concern; generating sales commissions is. Of course there is plenty of free advice out there, from Jim Cramer to Suze Orman. But, you will likely get what you pay for.
Finding good investments is very hard work. Buying them at the right price is even harder work. Having the patience to buy at the right time and sell at the right time is nearly impossible.
Your best bet is to invest in companies that pay monthly distributions. At least this way you get paid to ride things out or to recover your capital if your investment was poorly timed.
Saturday, September 11, 2010
Forced Investing
As we have seen, the whole concept of rising asset prices and stock investments constantly increasing in value is an economic illusion. What we are really seeing is our currency being devalued by the addition of new currency issued by the central bank. The prices of stocks, houses, gold, etc., do not really rise; they merely do better at keeping their value than do paper bills and digital checking accounts, since their supply is not increasing as fast as are paper bills and digital checking accounts.
"An improving economy neither consists of an increasing GDP nor does it cause the overall stock market to rise."
The fact that we have to save for the future is, in fact, an outrage. Were no money printed by the government and the banks, things would get cheaper through time, and we would not need much money for retirement, because it would cost much less to live each day then than it does now. But we are forced to invest in today's government-manipulated inflation-creation world in order to try to keep our purchasing power constant.
To the extent that some of us even come close to succeeding, we are still pushed further behind by having our "gains" taxed. The whole system of inflation is solely for the purpose of theft and wealth redistribution.
In a world absent of government printing presses and wealth taxes, the armies of investment advisors, pension-fund administrators, estate planners, lawyers, and accountants associated with helping us plan for the future would mostly not exist. These people would instead be employed in other industries producing goods and services that would truly increase our standards of living.
"An improving economy neither consists of an increasing GDP nor does it cause the overall stock market to rise."
The fact that we have to save for the future is, in fact, an outrage. Were no money printed by the government and the banks, things would get cheaper through time, and we would not need much money for retirement, because it would cost much less to live each day then than it does now. But we are forced to invest in today's government-manipulated inflation-creation world in order to try to keep our purchasing power constant.
To the extent that some of us even come close to succeeding, we are still pushed further behind by having our "gains" taxed. The whole system of inflation is solely for the purpose of theft and wealth redistribution.
In a world absent of government printing presses and wealth taxes, the armies of investment advisors, pension-fund administrators, estate planners, lawyers, and accountants associated with helping us plan for the future would mostly not exist. These people would instead be employed in other industries producing goods and services that would truly increase our standards of living.
Saturday, July 31, 2010
iShares That Pay Monthly Distributions
IShares that Pay Monthly Distributions
www.investingforincome.com
As an income investor I prefer investments that pay monthly distributions. For those that like exchange traded funds that trade on the TSX I suggest iShares.
Cash distributions for the eleven iShares funds listed on the Toronto Stock Exchange which pay on a monthly basis. Unitholders of record on the second to last business day of the month will receive cash distributions payable on last business day of the month. Details of the "per unit" distribution amounts are as follows:
----------------------------------------------------------------------------
Cash
Fund Distribution
Fund Name Ticker Per Unit ($)
----------------------------------------------------------------------------
iShares DEX Universe Bond Index Fund XBB 0.09828
----------------------------------------------------------------------------
iShares DEX All Corporate Bond Index Fund XCB 0.08879
----------------------------------------------------------------------------
iShares Dow Jones Canada Select Dividend Index Fund XDV 0.09638
----------------------------------------------------------------------------
iShares S&P/TSX Capped Financials Index Fund XFN 0.07515
----------------------------------------------------------------------------
iShares DEX All Government Bond Index Fund XGB 0.06154
----------------------------------------------------------------------------
iShares U.S. High Yield Bond Index Fund (CAD-Hedged) XHY 0.13200
----------------------------------------------------------------------------
iShares U.S. IG Corporate Bond Index Fund XIG 0.07016
----------------------------------------------------------------------------
iShares DEX Long Term Bond Index Fund XLB 0.07347
----------------------------------------------------------------------------
iShares S&P/TSX Capped REIT Index Fund XRE 0.05900
----------------------------------------------------------------------------
iShares DEX Short Term Bond Index Fund XSB 0.08410
----------------------------------------------------------------------------
iShares S&P/TSX Income Trust Index Fund XTR 0.06625
----------------------------------------------------------------------------
www.investingforincome.com
As an income investor I prefer investments that pay monthly distributions. For those that like exchange traded funds that trade on the TSX I suggest iShares.
Cash distributions for the eleven iShares funds listed on the Toronto Stock Exchange which pay on a monthly basis. Unitholders of record on the second to last business day of the month will receive cash distributions payable on last business day of the month. Details of the "per unit" distribution amounts are as follows:
----------------------------------------------------------------------------
Cash
Fund Distribution
Fund Name Ticker Per Unit ($)
----------------------------------------------------------------------------
iShares DEX Universe Bond Index Fund XBB 0.09828
----------------------------------------------------------------------------
iShares DEX All Corporate Bond Index Fund XCB 0.08879
----------------------------------------------------------------------------
iShares Dow Jones Canada Select Dividend Index Fund XDV 0.09638
----------------------------------------------------------------------------
iShares S&P/TSX Capped Financials Index Fund XFN 0.07515
----------------------------------------------------------------------------
iShares DEX All Government Bond Index Fund XGB 0.06154
----------------------------------------------------------------------------
iShares U.S. High Yield Bond Index Fund (CAD-Hedged) XHY 0.13200
----------------------------------------------------------------------------
iShares U.S. IG Corporate Bond Index Fund XIG 0.07016
----------------------------------------------------------------------------
iShares DEX Long Term Bond Index Fund XLB 0.07347
----------------------------------------------------------------------------
iShares S&P/TSX Capped REIT Index Fund XRE 0.05900
----------------------------------------------------------------------------
iShares DEX Short Term Bond Index Fund XSB 0.08410
----------------------------------------------------------------------------
iShares S&P/TSX Income Trust Index Fund XTR 0.06625
----------------------------------------------------------------------------
Sunday, June 13, 2010
The Great Reflation
The Great Reflation:
The Mother of all Financial Experiments Chuck Prince, the former CEO of Citigroup, who presided over the bank’s collapse, famously remarked in July 2007 that "as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”
Shortly after, the music stopped, the financial system broke, and Citigroup and other financial behemoths went under.
To rescue the economy and financial system from near‐total meltdown, the government created an unprecedented package of bailouts, stimulus, free money and massive fiscal deficits.
It succeeded, and a 1930s style debt deflation and depression were aborted. Liquidity, on a vast scale was unleashed into the financial system, demonstrating, once again, the power of such flows to drive up the prices of stocks, commodities and other risky assets.
In The Great Reflation we focus on how the authorities pumped air back into the balloon, and got the music playing again. Investors and banks, including Citigroup, are back out on the dance floor.
However, just because the system was saved, doesn’t mean it has been fixed. Why do we say that the system isn’t fixed? The major theme running through The Great Reflation is that we have been living through a multi‐decade period of money and credit inflation that started back in the 1960s when the post‐World War II global monetary system (Bretton Woods) began to break down. The Great Reflation is about this inflation and the consequences of the Act II, which is now unfolding.
From the late‐1960s until 1982 we had out‐of‐control price inflation; after that, a series of asset bubbles and mini‐crashes, leading up to The Big One in 2008‐2009. One of the implications outlined in The Great Reflation is that we continue to live in an age of money and credit inflation and a monetary system that is unanchored and has no brakes. Until that is fixed, monetary inflation and instability will be a way of life.
The great reflation can only be understood properly in this longer‐term context. It is a continuation of what went before, but with two main differences. The first is the sheer magnitude of the reflation this time—by far the biggest in peacetime U.S. history. The second difference is that the governments of the U.S. and other countries have had to transform collapsing private debt into a burgeoning public debt supercycle with projected government debt:GDP ratios heading to the stratosphere.
This effort to reflate—pump air back into the balloon—had to be on a scale at least as large as the bubble itself. It is an experiment never before attempted in the context of U.S. experience, and it will have consequences unlike anything seen before.
No one knows exactly where the great reflation is going, what is going to happen, and what the end point will be like. However, there are some things we do know. When new money is created on a grand scale, it must go somewhere and have some major consequences. One of these will be greatly increased volatility and instability in the economy and financial system compared with the roller‐coaster ride of the past 15 years when the private credit bubble was forming.
The Roller‐Coaster
It is critical for investors to understand that there has been a linked sequence of events since the 1960s that lead to the disaster of 2008‐2009. In particular, over the past 15 years, we experienced first the tech bubble, followed by a crash, then the recession and deflation of 2000‐2002.
Next came the Federal Reserve’s first effort at massive reflation to avoid a debt collapse. This led to new bubbles—in housing, exotic new financial products, commodity prices, energy, and world food markets. They were financed by an unprecedented credit bubble that was unsustainable. When the bubble burst, debt levels were much higher and more precarious than ever. In 2008‐2009 asset prices were crushed, causing the collateral behind the debt to evaporate. That, in turn, is what triggered the mother of all reflation experiments.
This sequence of events has an ominous undertone. The great reflation effort has clearly given the economy a big boost, just as the preceding one did but it is very artificial, based on free money and unprecedented fiscal deficits and subsidies to spending.
Extrapolation of this out‐of‐control roller coaster suggests more bubbles in the short run. Hot markets have already begun forming in such things as commodities, gold, and world stock markets.
There are many assets that could be recipients of the new money created. However, a warning for investors: We don’t believe another inflation of asset prices will last as long as the previous one for several reasons. Private debt has been pushed to the limit; government debt will be pushed to the limit in a few more years; the U.S. dollar, as the world’s main reserve currency, will not be able to withstand open‐ended monetary and fiscal reflation; and finally, the world economy is too fragile to withstand another spike in energy and food prices which will certainly occur if monetary inflation continues.
The great reflation, if left unchecked, will run into a brick wall in the next few years, and another credit implosion and deep recession will occur. The result will be even bigger budget deficits and lower economic growth. Logic says that if the recent crisis was caused by excessive money and credit inflation, even more of the same should cause an even bigger crisis. The ultimate end point to this trend is
worrisome, to say the least.
The Engine of Inflation Inflation is the biggest enemy of investors in the long run. However, in the short term, inflation in its early stages is often a wonderful elixir, greasing the wheels of the economy and causing riskier assets like stocks, commodities and corporate bonds to levitate. Euphoria tends to build as people get
richer.
But, it is important to understand that inflation is an undue expansion of money and credit. It can have the effect of raising the prices of things we consume or the prices of assets that we own or want to buy. But those are the symptoms of inflation that, if extreme, tell us that a bust is coming. In the case of rising consumer prices, the central bank ultimately has to raise interest rates and curtail credit. Recession follows. Or, if asset prices rise on the back of credit expansion, debt servicing ultimately becomes unbearable and asset prices—the collateral—start to fall, but debt levels are fixed in the short term. When people can’t service or repay debt, panics and crashes follow, and the risk of a debt deflation and depression rises dramatically.
Too much debt and falling asset prices caused the depression of the 1930s and almost another one in 2008‐2009. One Important reason that debt rose to such extremes, both in 1929 and 2007 was that the monetary system had a built‐in inflationary bias. In the 1920s, it was called the gold exchange standard, whereby countries held both gold and currencies in their reserves. In the post‐1971 world, it was called the floating dollar standard or Bretton Woods II. Countries held mainly dollars in their
reserves. As a result, the U.S. could inflate at will and foreign countries had to buy the excess dollars on the foreign exchange market if they wanted to prevent their currency from rising. In a world of low and falling price inflation, as was the case after 1982, almost all countries want a cheap currency.
This is an important consequence of our flawed monetary system. Countries that buy dollars to keep their currency depressed, experience money and credit inflation. Bubbles result.
When those countries re‐invest their dollars back into the U.S., the U.S. financial markets remain highly expansionary. Lenders keep lending and borrowers keep spending beyond their means. In a fixed exchange rate system in which countries do not hold dollar reserves, a U.S. international payments deficit results in a drain on domestic liquidity until the deficit is corrected. In the current system, the U.S. can inflate and run huge balance of payments deficits with no pain and no mechanism to stop it, other than a financial panic. It is like a fast car with no brakes. Sooner or later a crash occurs.
This fundamental flaw in the international monetary system remains. The combination of this with the unleashing of the great reflation has created a toxic brew. There is little wonder that people fear even greater monetary instability in the future than we have experienced.
When looking for scapegoats to point the finger of blame for the crash, it is natural that people have looked to the appalling performance of the regulators. That is valid, and it is also right to highlight the greed‐driven excesses of lenders and the virtually criminal conflicts of interest of the ratings agencies. But these characteristics—greed, conflict of interest and criminal behavior—are always present when inordinate inflations and manias occur. It is the inflation that is the real villain.
The Long Wave and Deflation The money and credit inflation following the breakdown of the Bretton Woods I system in 1971 originated, we believe, from the deflationary forces of the long wave decline that became quite evident after 1973. The private debt supercycle build‐up and overspending in the 1982‐2007 period caused a countertrend, but artificial, recovery in some long wave economic forces.
Employment, earnings and wealth in industries that benefitted from the credit inflation, such as real estate, the financial industry in general, retail spending, technology (from the 1990s bubble) rose quite strongly, masking the continued downward pressure on capital intensive industries and particularly, but not exclusively, in the capital goods industry itself.
Growing excess capacity resulted. Middle‐class incomes on average continued to erode and the gulf between rich and poor widened dramatically as in the late 1920s.
With the end of the private credit bubble, the long wave decline has resumed its downward course. No one knows how long that will last until the natural, Schumpeterian forces of long‐term renewal take over. This would include the implementation of new technologies and the development of new industries. Our guess is that it could take another five years or so.
Policy and Markets In The Great Reflation, we look at the inflationary causes of the credit bubble and the ensuing crash of 2008‐2009 and the consequences of the massive monetary and fiscal program that was needed to abort an incipient debt deflation like the 1930s. The world, and in particular the U.S., will remain very deflationary for a few more years as the post‐crash stimulus will soon begin to dissipate. The recovery engineered by the authorities will face additional headwinds from the unwinding of the private debt supercycle, the resumption of the long wave economic decline and the coming massive fiscal restraint.
The U.S. and almost all other governments, at both national and lower levels (states, provinces, municipalities, hospitals, etc.) will rein in expenditures and raise taxes. That is the new imperative—no one wants to hit the wall like Greece.
However, massive fiscal restraint also carries risks, just as the lack of restraint causes risks of a different sort. The big issue is whether there exists a middle ground thatcould eventually bring us to stability. That will only be revealed in the fullness of time. Spending and borrowing excesses of governments and the public have a long and dangerous history, suggesting a deeper malaise is affecting the nation. Moreover, there are other serious signs of long‐term decline, and policy and leadership will have to be particularly adroit in steering the U.S. through the difficult few years ahead.
It has been documented that the latter stages of a long wave decline are parochial, nasty and politically unstable. People are fed up with the system, their loss of wealth, jobs, and income. Traditional politicians are blamed. People look for quick and easy solutions and are open to simplistic solutions provided by demagogues. It is difficult to sell the austerity, sound policies and pro‐growth strategies needed to transition through the long wave trough before really big crises occur. Countries in denial face the prospect of repeating Greece’s calamity.
The risk for the U.S. and other countries is that politicians will cater to populist
pressures and impose spending and tax policies that are counterproductive. In the aftermath of the Great Reflation, this could mean more government programs (e.g. health care), failure to raise taxes, where appropriate, out of fear of losing office, and excessive monetary ease because the Treasury bond market cannot absorb government funding on its own.
However, we should avoid the temptation to get too pessimistic. It is important never to underestimate the ability of the U.S. to recover from adversity, rejuvenate itself and get its house in order. Its long‐term track record is pretty good, and realistic hope should not be jettisoned too readily.
The question remains however, as to whether the U.S. needs an economic Pearl Harbour before serious action is taken. Investors have seen empty promises many times before and hence should be sceptical until they see clear, positive evidence that such action is being taken. Until then, they should take the attitude “show me”.
The Investment Challenge The great problem for investors in today’s environment is that there is no return on short‐term, safe assets yet the higher risk levels on longer‐term, higher return assets are too uncomfortable for most people.
They are the single most important force driving investment markets both up and down. Contracting liquidity caused the crash in 2008‐2009 and dramatically expanding liquidity since March 2009 has triggered one of the greatest bull markets in U.S. history. The next bear market will also be driven, at some point, by a contraction in liquidity flows. However, as long as the great reflation is doing its work, that day can be postponed. Chuck Prince, if he were to comment today, would probably point out that the music is playing again. People are back out on the dance floor. But, if the great reflation is as artificial as we believe, then this is still musical chairs. When the music stops, there won’t be a chair for everyone, just like the last time.
Tony Boeckh
The Mother of all Financial Experiments Chuck Prince, the former CEO of Citigroup, who presided over the bank’s collapse, famously remarked in July 2007 that "as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”
Shortly after, the music stopped, the financial system broke, and Citigroup and other financial behemoths went under.
To rescue the economy and financial system from near‐total meltdown, the government created an unprecedented package of bailouts, stimulus, free money and massive fiscal deficits.
It succeeded, and a 1930s style debt deflation and depression were aborted. Liquidity, on a vast scale was unleashed into the financial system, demonstrating, once again, the power of such flows to drive up the prices of stocks, commodities and other risky assets.
In The Great Reflation we focus on how the authorities pumped air back into the balloon, and got the music playing again. Investors and banks, including Citigroup, are back out on the dance floor.
However, just because the system was saved, doesn’t mean it has been fixed. Why do we say that the system isn’t fixed? The major theme running through The Great Reflation is that we have been living through a multi‐decade period of money and credit inflation that started back in the 1960s when the post‐World War II global monetary system (Bretton Woods) began to break down. The Great Reflation is about this inflation and the consequences of the Act II, which is now unfolding.
From the late‐1960s until 1982 we had out‐of‐control price inflation; after that, a series of asset bubbles and mini‐crashes, leading up to The Big One in 2008‐2009. One of the implications outlined in The Great Reflation is that we continue to live in an age of money and credit inflation and a monetary system that is unanchored and has no brakes. Until that is fixed, monetary inflation and instability will be a way of life.
The great reflation can only be understood properly in this longer‐term context. It is a continuation of what went before, but with two main differences. The first is the sheer magnitude of the reflation this time—by far the biggest in peacetime U.S. history. The second difference is that the governments of the U.S. and other countries have had to transform collapsing private debt into a burgeoning public debt supercycle with projected government debt:GDP ratios heading to the stratosphere.
This effort to reflate—pump air back into the balloon—had to be on a scale at least as large as the bubble itself. It is an experiment never before attempted in the context of U.S. experience, and it will have consequences unlike anything seen before.
No one knows exactly where the great reflation is going, what is going to happen, and what the end point will be like. However, there are some things we do know. When new money is created on a grand scale, it must go somewhere and have some major consequences. One of these will be greatly increased volatility and instability in the economy and financial system compared with the roller‐coaster ride of the past 15 years when the private credit bubble was forming.
The Roller‐Coaster
It is critical for investors to understand that there has been a linked sequence of events since the 1960s that lead to the disaster of 2008‐2009. In particular, over the past 15 years, we experienced first the tech bubble, followed by a crash, then the recession and deflation of 2000‐2002.
Next came the Federal Reserve’s first effort at massive reflation to avoid a debt collapse. This led to new bubbles—in housing, exotic new financial products, commodity prices, energy, and world food markets. They were financed by an unprecedented credit bubble that was unsustainable. When the bubble burst, debt levels were much higher and more precarious than ever. In 2008‐2009 asset prices were crushed, causing the collateral behind the debt to evaporate. That, in turn, is what triggered the mother of all reflation experiments.
This sequence of events has an ominous undertone. The great reflation effort has clearly given the economy a big boost, just as the preceding one did but it is very artificial, based on free money and unprecedented fiscal deficits and subsidies to spending.
Extrapolation of this out‐of‐control roller coaster suggests more bubbles in the short run. Hot markets have already begun forming in such things as commodities, gold, and world stock markets.
There are many assets that could be recipients of the new money created. However, a warning for investors: We don’t believe another inflation of asset prices will last as long as the previous one for several reasons. Private debt has been pushed to the limit; government debt will be pushed to the limit in a few more years; the U.S. dollar, as the world’s main reserve currency, will not be able to withstand open‐ended monetary and fiscal reflation; and finally, the world economy is too fragile to withstand another spike in energy and food prices which will certainly occur if monetary inflation continues.
The great reflation, if left unchecked, will run into a brick wall in the next few years, and another credit implosion and deep recession will occur. The result will be even bigger budget deficits and lower economic growth. Logic says that if the recent crisis was caused by excessive money and credit inflation, even more of the same should cause an even bigger crisis. The ultimate end point to this trend is
worrisome, to say the least.
The Engine of Inflation Inflation is the biggest enemy of investors in the long run. However, in the short term, inflation in its early stages is often a wonderful elixir, greasing the wheels of the economy and causing riskier assets like stocks, commodities and corporate bonds to levitate. Euphoria tends to build as people get
richer.
But, it is important to understand that inflation is an undue expansion of money and credit. It can have the effect of raising the prices of things we consume or the prices of assets that we own or want to buy. But those are the symptoms of inflation that, if extreme, tell us that a bust is coming. In the case of rising consumer prices, the central bank ultimately has to raise interest rates and curtail credit. Recession follows. Or, if asset prices rise on the back of credit expansion, debt servicing ultimately becomes unbearable and asset prices—the collateral—start to fall, but debt levels are fixed in the short term. When people can’t service or repay debt, panics and crashes follow, and the risk of a debt deflation and depression rises dramatically.
Too much debt and falling asset prices caused the depression of the 1930s and almost another one in 2008‐2009. One Important reason that debt rose to such extremes, both in 1929 and 2007 was that the monetary system had a built‐in inflationary bias. In the 1920s, it was called the gold exchange standard, whereby countries held both gold and currencies in their reserves. In the post‐1971 world, it was called the floating dollar standard or Bretton Woods II. Countries held mainly dollars in their
reserves. As a result, the U.S. could inflate at will and foreign countries had to buy the excess dollars on the foreign exchange market if they wanted to prevent their currency from rising. In a world of low and falling price inflation, as was the case after 1982, almost all countries want a cheap currency.
This is an important consequence of our flawed monetary system. Countries that buy dollars to keep their currency depressed, experience money and credit inflation. Bubbles result.
When those countries re‐invest their dollars back into the U.S., the U.S. financial markets remain highly expansionary. Lenders keep lending and borrowers keep spending beyond their means. In a fixed exchange rate system in which countries do not hold dollar reserves, a U.S. international payments deficit results in a drain on domestic liquidity until the deficit is corrected. In the current system, the U.S. can inflate and run huge balance of payments deficits with no pain and no mechanism to stop it, other than a financial panic. It is like a fast car with no brakes. Sooner or later a crash occurs.
This fundamental flaw in the international monetary system remains. The combination of this with the unleashing of the great reflation has created a toxic brew. There is little wonder that people fear even greater monetary instability in the future than we have experienced.
When looking for scapegoats to point the finger of blame for the crash, it is natural that people have looked to the appalling performance of the regulators. That is valid, and it is also right to highlight the greed‐driven excesses of lenders and the virtually criminal conflicts of interest of the ratings agencies. But these characteristics—greed, conflict of interest and criminal behavior—are always present when inordinate inflations and manias occur. It is the inflation that is the real villain.
The Long Wave and Deflation The money and credit inflation following the breakdown of the Bretton Woods I system in 1971 originated, we believe, from the deflationary forces of the long wave decline that became quite evident after 1973. The private debt supercycle build‐up and overspending in the 1982‐2007 period caused a countertrend, but artificial, recovery in some long wave economic forces.
Employment, earnings and wealth in industries that benefitted from the credit inflation, such as real estate, the financial industry in general, retail spending, technology (from the 1990s bubble) rose quite strongly, masking the continued downward pressure on capital intensive industries and particularly, but not exclusively, in the capital goods industry itself.
Growing excess capacity resulted. Middle‐class incomes on average continued to erode and the gulf between rich and poor widened dramatically as in the late 1920s.
With the end of the private credit bubble, the long wave decline has resumed its downward course. No one knows how long that will last until the natural, Schumpeterian forces of long‐term renewal take over. This would include the implementation of new technologies and the development of new industries. Our guess is that it could take another five years or so.
Policy and Markets In The Great Reflation, we look at the inflationary causes of the credit bubble and the ensuing crash of 2008‐2009 and the consequences of the massive monetary and fiscal program that was needed to abort an incipient debt deflation like the 1930s. The world, and in particular the U.S., will remain very deflationary for a few more years as the post‐crash stimulus will soon begin to dissipate. The recovery engineered by the authorities will face additional headwinds from the unwinding of the private debt supercycle, the resumption of the long wave economic decline and the coming massive fiscal restraint.
The U.S. and almost all other governments, at both national and lower levels (states, provinces, municipalities, hospitals, etc.) will rein in expenditures and raise taxes. That is the new imperative—no one wants to hit the wall like Greece.
However, massive fiscal restraint also carries risks, just as the lack of restraint causes risks of a different sort. The big issue is whether there exists a middle ground thatcould eventually bring us to stability. That will only be revealed in the fullness of time. Spending and borrowing excesses of governments and the public have a long and dangerous history, suggesting a deeper malaise is affecting the nation. Moreover, there are other serious signs of long‐term decline, and policy and leadership will have to be particularly adroit in steering the U.S. through the difficult few years ahead.
It has been documented that the latter stages of a long wave decline are parochial, nasty and politically unstable. People are fed up with the system, their loss of wealth, jobs, and income. Traditional politicians are blamed. People look for quick and easy solutions and are open to simplistic solutions provided by demagogues. It is difficult to sell the austerity, sound policies and pro‐growth strategies needed to transition through the long wave trough before really big crises occur. Countries in denial face the prospect of repeating Greece’s calamity.
The risk for the U.S. and other countries is that politicians will cater to populist
pressures and impose spending and tax policies that are counterproductive. In the aftermath of the Great Reflation, this could mean more government programs (e.g. health care), failure to raise taxes, where appropriate, out of fear of losing office, and excessive monetary ease because the Treasury bond market cannot absorb government funding on its own.
However, we should avoid the temptation to get too pessimistic. It is important never to underestimate the ability of the U.S. to recover from adversity, rejuvenate itself and get its house in order. Its long‐term track record is pretty good, and realistic hope should not be jettisoned too readily.
The question remains however, as to whether the U.S. needs an economic Pearl Harbour before serious action is taken. Investors have seen empty promises many times before and hence should be sceptical until they see clear, positive evidence that such action is being taken. Until then, they should take the attitude “show me”.
The Investment Challenge The great problem for investors in today’s environment is that there is no return on short‐term, safe assets yet the higher risk levels on longer‐term, higher return assets are too uncomfortable for most people.
They are the single most important force driving investment markets both up and down. Contracting liquidity caused the crash in 2008‐2009 and dramatically expanding liquidity since March 2009 has triggered one of the greatest bull markets in U.S. history. The next bear market will also be driven, at some point, by a contraction in liquidity flows. However, as long as the great reflation is doing its work, that day can be postponed. Chuck Prince, if he were to comment today, would probably point out that the music is playing again. People are back out on the dance floor. But, if the great reflation is as artificial as we believe, then this is still musical chairs. When the music stops, there won’t be a chair for everyone, just like the last time.
Tony Boeckh
Sunday, April 25, 2010
If You Are So Smart Then Why Aren't You Rich?
Are the Rich Smarter Than You?
"Well if you're so damn smart, why aren't you rich?"
I never knew how to respond to this. Still, it ingrained in us the notion that the rich must have a little something extra going on upstairs, otherwise we'd all be rolling in it. Right?
There is, in fact, some evidence to support this.
According to a recent report from the U.S. Census Bureau, there is a strong positive correlation between education and income. Over an adult's working life, high school graduates should expect, on average, to earn $1.2 million; those with a bachelor's degree, $2.1 million; those with a master's degree, $2.5 million; those with doctoral degrees, $3.4 million; and those with professional de grees, $4.4 million.
But here's the rub: Studies show that those who earn the most aren't necessarily the richest. To determine real wealth, you need to look at a balance sheet - assets minus liabilities - not an income statement.
We generally envision millionaires as Lexus-driving, Rolex-wearing, mansion-owning, Tiffany-shopping members of exclusive country clubs. And indeed, Stanley's research reveals that the "glittering rich" - those with a net worth of $10 million or more - often meet this description.
But most millionaires - individuals with a net worth of $1 million or more - live an entirely different lifestyle. Stanley found that the vast majority:
• Live in a house that cost less than $400,000.
• Do not own a second home.
• Have never owned a boat.
• Are more likely to wear a Timex than a Rolex.
• Do not collect wine and generally pay less than $15 for a bottle.
• Are more likely to drive a Nissan than a BMW.
• Have never paid more than $400 for a suit.
• Spend very little on prestige brands and luxury items.
This is certainly not the traditional image of millionaires. And it makes you wonder, just who the heck is buying all those Mercedes convertibles, Louis Vuitton purses and $60 bottles of Grey Goose vodka?
The answer, according to Dr. Stanley, is "aspirationals" - people who act rich, want to be rich, but really aren't rich.
Many are good people, well educated and perhaps earning a six-figure income. But they aren't balance-sheet rich because it's almost impossible for most workers - even those who are highly paid - to hyper-spend on consumer goods and save a lot of money. (Unfortunately, saving is the key prerequisite for investing.)
In his new book, Stop Acting Rich... and Start Living Like a Real Millionaire, Dr. Stanley recalls an appearance on Oprah when a member of the audience asked the question - one he's heard hundreds of times before:
"What good does it do to have all this money if you don't spend it?" She was angry, indignant even. "These people couldn't possibly be happy."
Like so many others, this woman genuinely believed that the more you spend, the better life is.
Bear in mind, we're not talking about people living below the poverty line. We're talking about middle-class consumers and up who have lived beyond their means and have suddenly found themselves under enormous pressure in a weak economy.
Some were overly optimistic. Others didn't realize that they are up against an army of the best and most creative marketers in the world, whose job it is to convince you that "you are what you buy," that you need to outspend - to out-display - others.
The unspoken message behind the constant barrage of TV and billboard ads featuring all those impossibly good-looking men and women is that you are special, you are deserving, and you need to look and act successful now.
According to Dr. Stanley, "The pseudo-affluent are insecure about how they rank among the Joneses and the Smiths. Often their self-esteem rests on quicksand. In their minds, it is closely tied to how long they can continue to purchase the trappings of wealth. They strongly believe all economically successful people display their success through prestige products. The flip side of this has them believing that people who do not own prestige brands are not successful."
Yet "everyday" millionaires see things differently. Most of them achieved their wealth not by hitting the lottery or gaining an inheritance, but by patiently and persistently maximizing their income, minimizing their outgo and religiously saving and investing the difference.
They aren't big spenders. According to Stanley's surveys, their most popular activities include:
• Socializing with children/grandchildren (95%)
• Planning investments (94%)
• Entertaining close friends (87%)
• Visiting museums (83%)
• Raising funds for charities (75%)
• Attending sporting events (69%)
• Participating in civic activities (69%)
• Studying art (63%)
• Participating in trade/professional association activities (56%)
• Gardening (55%)
• Attending religious services (52%)
• Jogging (48%)
• Attending lectures (44%)
You'll notice the cost associated with these activities is minimal. Most millionaires understand that real pleasure and satisfaction don't come from the car you drive or the watch you wear, but time spent in enjoyable activities with family, friends and associates.
Yet they aren't misers, especially when it comes to educating their children and grandchildren - or donating to worthy causes. Although they are disciplined savers, the affluent are among the most generous Americans in charitable giving.
They "give" in another important way, too. According to the IRS, the top 1% of America's income earners pay 37% of the entire federal income tax bill. The top 5% pay 57%. The top 10% pay 68%. (The bottom 50% pay less than 4%.) It's a far cry from the populist complaint that the rich "don't pay their fair share."
Just how prevalent are American millionaires?
According to the Spectrum Group, there were 6.7 million U.S. households with a net worth of at least $1 million at the end of 2008. Very few of them won a Grammy, played in the NBA or started a computer company in their garage. Clearly, thrift and modesty - however unfashionable - are still alive in some parts of the country.
So while millions of consumers chase a blinkered image of success - busting their humps for stuff that ends up in landfills, yard sales and thrift shops - disciplined savers and investors are enjoying the freedom, satisfaction and peace of mind that comes from living beneath their means.
More often than not, these folks are turned on not by consumerism but by personal achievement, industry awards and recognition.
They know that success is not about flaunting your wealth. It's about a sense of accomplishment... and the independence that comes with it. They are able to do what they want, where they want, with whom they want.
They may not be smarter than you, but they do know something priceless:
It's how we spend ourselves - not our money - that makes us rich.
"Well if you're so damn smart, why aren't you rich?"
I never knew how to respond to this. Still, it ingrained in us the notion that the rich must have a little something extra going on upstairs, otherwise we'd all be rolling in it. Right?
There is, in fact, some evidence to support this.
According to a recent report from the U.S. Census Bureau, there is a strong positive correlation between education and income. Over an adult's working life, high school graduates should expect, on average, to earn $1.2 million; those with a bachelor's degree, $2.1 million; those with a master's degree, $2.5 million; those with doctoral degrees, $3.4 million; and those with professional de grees, $4.4 million.
But here's the rub: Studies show that those who earn the most aren't necessarily the richest. To determine real wealth, you need to look at a balance sheet - assets minus liabilities - not an income statement.
We generally envision millionaires as Lexus-driving, Rolex-wearing, mansion-owning, Tiffany-shopping members of exclusive country clubs. And indeed, Stanley's research reveals that the "glittering rich" - those with a net worth of $10 million or more - often meet this description.
But most millionaires - individuals with a net worth of $1 million or more - live an entirely different lifestyle. Stanley found that the vast majority:
• Live in a house that cost less than $400,000.
• Do not own a second home.
• Have never owned a boat.
• Are more likely to wear a Timex than a Rolex.
• Do not collect wine and generally pay less than $15 for a bottle.
• Are more likely to drive a Nissan than a BMW.
• Have never paid more than $400 for a suit.
• Spend very little on prestige brands and luxury items.
This is certainly not the traditional image of millionaires. And it makes you wonder, just who the heck is buying all those Mercedes convertibles, Louis Vuitton purses and $60 bottles of Grey Goose vodka?
The answer, according to Dr. Stanley, is "aspirationals" - people who act rich, want to be rich, but really aren't rich.
Many are good people, well educated and perhaps earning a six-figure income. But they aren't balance-sheet rich because it's almost impossible for most workers - even those who are highly paid - to hyper-spend on consumer goods and save a lot of money. (Unfortunately, saving is the key prerequisite for investing.)
In his new book, Stop Acting Rich... and Start Living Like a Real Millionaire, Dr. Stanley recalls an appearance on Oprah when a member of the audience asked the question - one he's heard hundreds of times before:
"What good does it do to have all this money if you don't spend it?" She was angry, indignant even. "These people couldn't possibly be happy."
Like so many others, this woman genuinely believed that the more you spend, the better life is.
Bear in mind, we're not talking about people living below the poverty line. We're talking about middle-class consumers and up who have lived beyond their means and have suddenly found themselves under enormous pressure in a weak economy.
Some were overly optimistic. Others didn't realize that they are up against an army of the best and most creative marketers in the world, whose job it is to convince you that "you are what you buy," that you need to outspend - to out-display - others.
The unspoken message behind the constant barrage of TV and billboard ads featuring all those impossibly good-looking men and women is that you are special, you are deserving, and you need to look and act successful now.
According to Dr. Stanley, "The pseudo-affluent are insecure about how they rank among the Joneses and the Smiths. Often their self-esteem rests on quicksand. In their minds, it is closely tied to how long they can continue to purchase the trappings of wealth. They strongly believe all economically successful people display their success through prestige products. The flip side of this has them believing that people who do not own prestige brands are not successful."
Yet "everyday" millionaires see things differently. Most of them achieved their wealth not by hitting the lottery or gaining an inheritance, but by patiently and persistently maximizing their income, minimizing their outgo and religiously saving and investing the difference.
They aren't big spenders. According to Stanley's surveys, their most popular activities include:
• Socializing with children/grandchildren (95%)
• Planning investments (94%)
• Entertaining close friends (87%)
• Visiting museums (83%)
• Raising funds for charities (75%)
• Attending sporting events (69%)
• Participating in civic activities (69%)
• Studying art (63%)
• Participating in trade/professional association activities (56%)
• Gardening (55%)
• Attending religious services (52%)
• Jogging (48%)
• Attending lectures (44%)
You'll notice the cost associated with these activities is minimal. Most millionaires understand that real pleasure and satisfaction don't come from the car you drive or the watch you wear, but time spent in enjoyable activities with family, friends and associates.
Yet they aren't misers, especially when it comes to educating their children and grandchildren - or donating to worthy causes. Although they are disciplined savers, the affluent are among the most generous Americans in charitable giving.
They "give" in another important way, too. According to the IRS, the top 1% of America's income earners pay 37% of the entire federal income tax bill. The top 5% pay 57%. The top 10% pay 68%. (The bottom 50% pay less than 4%.) It's a far cry from the populist complaint that the rich "don't pay their fair share."
Just how prevalent are American millionaires?
According to the Spectrum Group, there were 6.7 million U.S. households with a net worth of at least $1 million at the end of 2008. Very few of them won a Grammy, played in the NBA or started a computer company in their garage. Clearly, thrift and modesty - however unfashionable - are still alive in some parts of the country.
So while millions of consumers chase a blinkered image of success - busting their humps for stuff that ends up in landfills, yard sales and thrift shops - disciplined savers and investors are enjoying the freedom, satisfaction and peace of mind that comes from living beneath their means.
More often than not, these folks are turned on not by consumerism but by personal achievement, industry awards and recognition.
They know that success is not about flaunting your wealth. It's about a sense of accomplishment... and the independence that comes with it. They are able to do what they want, where they want, with whom they want.
They may not be smarter than you, but they do know something priceless:
It's how we spend ourselves - not our money - that makes us rich.
Sunday, April 11, 2010
The Age of Inflation
In this age of inflation, we are all forced to do many tasks that others could do better for us. The fact is that inflation impedes the process of civilization, which is brought about by the division of labor. While, without the central bank's continual monetary infusions, prices would gently fall as technology made all things and all people more efficient, we don't enjoy that luxury. Instead we're mowing our own grass, fixing the flappers in our toilet tanks, and managing our own retirement funds.
Now, pushing a mower requires little skill, is no more than an annoyance, and provides the benefits of fresh air and sunshine. But managing one's retirement funds is a different matter entirely. It is an especially cruel result of inflation that instead of simply being able to hoard money, people must "invest their money into the financial markets, lest its purchasing power evaporate under their noses," explains Jörg Guido Hülsmann in The Ethics of Money Production. "Thus they become dependent on intermediaries and on the vagaries of stock and bond pricing." And unfortunately most of us aren't neurologically wired well for the job.
But we can't just throw up our hands and trust the state to take care of us in our golden years. Saving money isn't enough. The state is continually making what you have saved worth less. And unless you're a government employee, most likely you're left with the assignment of making sure you have enough for when emergencies occur or you're unable to work.
The typical stockbroker went from selling shoes or cars to hustling stocks after passing the Series 7 exam. Your financial future is not his or her concern; generating sales commissions is. Of course there is plenty of free advice out there, from Jim Cramer to Suze Orman. But, you will likely get what you pay for. Finding good investments is very hard work. Buying them at the right price is even harder work. Having the patience to buy at the right time and sell at the right time is nearly impossible.
Austrian business-cycle theory can give investors ideas on when to invest and what to invest in, but the Austrian School provides little in the way of analyzing specific companies and stock prices. What Hayek and Mises are to the business cycle, Benjamin Graham and David Dodd are to value investing. In their famous treatise, Security Analysis, Graham and Dodd painstakingly lay out their method for valuing stocks, looking for deeply depressed prices.
"Saving money isn't enough. The state is continually making what you have saved worth less."
While the average amateur investor may be excellent in their own career field, it doesn't mean they know what to invest in, or how to pick stocks. In fact being very good at your field can give you the false sense that whatever stocks you pick or your broker picks for you must be good, because after all, you picked them and you picked your broker — and you're smart. So, no doubt those stock prices will go up.
But the smart and talented stock-picking neophyte is not investing at all but speculating. "An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return," Ben Graham wrote. "Operations not meeting these requirements are speculative." The vast majority of people just don't have the time or possess the patience to thoroughly analyze an investment opportunity. In The Millionaire Next Door, authors Thomas Stanley and William Danko point out that the average person tends to spend more time on purchasing a car than on looking at potential appreciating investments.
So for those who are interested in accumulating wealth and willing to put the time and hard work toward that end, Joseph Calandro, Jr. has masterfully melded the work of Graham and Dodd with Austrian business-cycle theory. The result is a very readable how-to guide for value investing, aptly named Applied Value Investing: The Practical Application of Benjamin Graham and Warren Buffet's Valuation Principles to Acquisitions, Catastrophe Pricing and Business Execution.
One can see by the title that the book is not for someone looking to take the next step after Stock Investing For Dummies, but it's not the handful that the title implies. The beauty of Calandro's work is that he teaches value investing through case studies. The reader can follow along while the author does his own valuations of Sears, GEICO, and General Re. These of course are not made-up theoretical cases, but real-life deals made by value investors Eddie Lambert and Warren Buffett.
Calandro first provides the reader with the basics of Graham and Dodd valuation in order to be "approximately right rather than precisely wrong." The author does this by valuing Delta Apparel, Inc., as a potential investment in 2002. When his analysis indicated that Delta was undervalued, Calandro bought Delta stocks and immediately offered to resell them at a fairer, higher price. This exercise is all about making money, not falling in love with stocks and their stories.
Much of Graham and Dodd's analysis is in assigning different valuations to balance-sheet items to determine what the real value of a company is beyond the accounting. This requires much more art than science.
"Finding good investments is very hard work. Buying them at the right price is even harder work. Having the patience to buy at the right time and sell at the right time is nearly impossible."
A couple of reviewers of Applied Value Investing have taken Calandro to task for the assumptions he makes in his case studies. Although the author doesn't provide much explanation of many of his assumptions, readers should understand that the talent of investing comes through experience and training. Reading one book will not provide all the answers, but Calandro does give us a roadmap. Investors must still make their own judgments.
These reviewers may not have made it to the book's conclusion, where the author reminds us that applied value investing is all about "identifying what you know and what you do not know, and then taking steps to quantify what you do know in a conservative yet rigorous manner so that a disciplined valuation can be formulated."
In chapter 5, the author draws upon an article he wrote for the Quarterly Journal of Austrian Economics to give the reader/investor insights into the best times to buy and sell from a macro perspective. He breaks the business cycle into eight stages by "synthesizing [George] Soros's boom–bust model, Austrian business cycle theory (ABCT), and behavioral characteristics."
In an interesting appendix to the chapter, Calandro writes of Warren Buffett's criticism of the efficient-markets hypothesis (EMH), which is the Rational Expectations School of the investing world. EMH posits that prices on assets traded in the market already reflect all available information. The Oracle of Omaha refuses to donate money to his alma mater, Columbia, because of the school's research in the area of EMH.
After applying Graham and Dodd valuation to make a catastrophe valuation, the author applies his tools to firms' business strategies. Next he circles back and discusses the important aspects of each layer of value-investing analysis, emphasizing that the key to long-term success is "research, checking, rechecking and cross-checking of assumptions."
To conclude, the author tells the reader to ignore economists shilling for newspapers, TV shows, political parties, the government, or financial institutions. Calandro quotes renowned Fidelity Fund manager Peter Lynch, who said, "If you spend 13 minutes a year on economics, you've wasted 10 minutes." However, Calandro recommends, in addition to a number of other books, Murray Rothbard's America's Great Depression, Roger Garrison's Time and Money, Ludwig von Mises's The Theory of Money and Credit, and other Austrian titles. With all due respect to Peter Lynch, Mises — a real economist — wrote that economics "concerns everyone and belongs to all. It is the main and proper study of every citizen."
And while the practice of value investing the Graham and Dodd way is more prudent than throwing money at that stock tip you overheard at the bar the other night, always remember what Mises wrote in Human Action: "There is no such thing as a nonspeculative investment.… In a changing economy action always involves speculation. Investments may be good or bad, but they are always speculative."
Now, pushing a mower requires little skill, is no more than an annoyance, and provides the benefits of fresh air and sunshine. But managing one's retirement funds is a different matter entirely. It is an especially cruel result of inflation that instead of simply being able to hoard money, people must "invest their money into the financial markets, lest its purchasing power evaporate under their noses," explains Jörg Guido Hülsmann in The Ethics of Money Production. "Thus they become dependent on intermediaries and on the vagaries of stock and bond pricing." And unfortunately most of us aren't neurologically wired well for the job.
But we can't just throw up our hands and trust the state to take care of us in our golden years. Saving money isn't enough. The state is continually making what you have saved worth less. And unless you're a government employee, most likely you're left with the assignment of making sure you have enough for when emergencies occur or you're unable to work.
The typical stockbroker went from selling shoes or cars to hustling stocks after passing the Series 7 exam. Your financial future is not his or her concern; generating sales commissions is. Of course there is plenty of free advice out there, from Jim Cramer to Suze Orman. But, you will likely get what you pay for. Finding good investments is very hard work. Buying them at the right price is even harder work. Having the patience to buy at the right time and sell at the right time is nearly impossible.
Austrian business-cycle theory can give investors ideas on when to invest and what to invest in, but the Austrian School provides little in the way of analyzing specific companies and stock prices. What Hayek and Mises are to the business cycle, Benjamin Graham and David Dodd are to value investing. In their famous treatise, Security Analysis, Graham and Dodd painstakingly lay out their method for valuing stocks, looking for deeply depressed prices.
"Saving money isn't enough. The state is continually making what you have saved worth less."
While the average amateur investor may be excellent in their own career field, it doesn't mean they know what to invest in, or how to pick stocks. In fact being very good at your field can give you the false sense that whatever stocks you pick or your broker picks for you must be good, because after all, you picked them and you picked your broker — and you're smart. So, no doubt those stock prices will go up.
But the smart and talented stock-picking neophyte is not investing at all but speculating. "An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return," Ben Graham wrote. "Operations not meeting these requirements are speculative." The vast majority of people just don't have the time or possess the patience to thoroughly analyze an investment opportunity. In The Millionaire Next Door, authors Thomas Stanley and William Danko point out that the average person tends to spend more time on purchasing a car than on looking at potential appreciating investments.
So for those who are interested in accumulating wealth and willing to put the time and hard work toward that end, Joseph Calandro, Jr. has masterfully melded the work of Graham and Dodd with Austrian business-cycle theory. The result is a very readable how-to guide for value investing, aptly named Applied Value Investing: The Practical Application of Benjamin Graham and Warren Buffet's Valuation Principles to Acquisitions, Catastrophe Pricing and Business Execution.
One can see by the title that the book is not for someone looking to take the next step after Stock Investing For Dummies, but it's not the handful that the title implies. The beauty of Calandro's work is that he teaches value investing through case studies. The reader can follow along while the author does his own valuations of Sears, GEICO, and General Re. These of course are not made-up theoretical cases, but real-life deals made by value investors Eddie Lambert and Warren Buffett.
Calandro first provides the reader with the basics of Graham and Dodd valuation in order to be "approximately right rather than precisely wrong." The author does this by valuing Delta Apparel, Inc., as a potential investment in 2002. When his analysis indicated that Delta was undervalued, Calandro bought Delta stocks and immediately offered to resell them at a fairer, higher price. This exercise is all about making money, not falling in love with stocks and their stories.
Much of Graham and Dodd's analysis is in assigning different valuations to balance-sheet items to determine what the real value of a company is beyond the accounting. This requires much more art than science.
"Finding good investments is very hard work. Buying them at the right price is even harder work. Having the patience to buy at the right time and sell at the right time is nearly impossible."
A couple of reviewers of Applied Value Investing have taken Calandro to task for the assumptions he makes in his case studies. Although the author doesn't provide much explanation of many of his assumptions, readers should understand that the talent of investing comes through experience and training. Reading one book will not provide all the answers, but Calandro does give us a roadmap. Investors must still make their own judgments.
These reviewers may not have made it to the book's conclusion, where the author reminds us that applied value investing is all about "identifying what you know and what you do not know, and then taking steps to quantify what you do know in a conservative yet rigorous manner so that a disciplined valuation can be formulated."
In chapter 5, the author draws upon an article he wrote for the Quarterly Journal of Austrian Economics to give the reader/investor insights into the best times to buy and sell from a macro perspective. He breaks the business cycle into eight stages by "synthesizing [George] Soros's boom–bust model, Austrian business cycle theory (ABCT), and behavioral characteristics."
In an interesting appendix to the chapter, Calandro writes of Warren Buffett's criticism of the efficient-markets hypothesis (EMH), which is the Rational Expectations School of the investing world. EMH posits that prices on assets traded in the market already reflect all available information. The Oracle of Omaha refuses to donate money to his alma mater, Columbia, because of the school's research in the area of EMH.
After applying Graham and Dodd valuation to make a catastrophe valuation, the author applies his tools to firms' business strategies. Next he circles back and discusses the important aspects of each layer of value-investing analysis, emphasizing that the key to long-term success is "research, checking, rechecking and cross-checking of assumptions."
To conclude, the author tells the reader to ignore economists shilling for newspapers, TV shows, political parties, the government, or financial institutions. Calandro quotes renowned Fidelity Fund manager Peter Lynch, who said, "If you spend 13 minutes a year on economics, you've wasted 10 minutes." However, Calandro recommends, in addition to a number of other books, Murray Rothbard's America's Great Depression, Roger Garrison's Time and Money, Ludwig von Mises's The Theory of Money and Credit, and other Austrian titles. With all due respect to Peter Lynch, Mises — a real economist — wrote that economics "concerns everyone and belongs to all. It is the main and proper study of every citizen."
And while the practice of value investing the Graham and Dodd way is more prudent than throwing money at that stock tip you overheard at the bar the other night, always remember what Mises wrote in Human Action: "There is no such thing as a nonspeculative investment.… In a changing economy action always involves speculation. Investments may be good or bad, but they are always speculative."
Saturday, March 13, 2010
Investing for Income Rethink
For many years we have been taught that our investments should be split between stocks and bonds. Stocks for growth, and bonds for income. With extreme volatility in the stock markets in recent years and record low interest rates on bonds, many investors have questioned their asset mix.
Investors are increasingly looking for alternative income-generating investments, that give more than the meager returns on bonds and GIC's and greater stability than the stock market has given them.
Investors are increasingly looking for alternative income-generating investments, that give more than the meager returns on bonds and GIC's and greater stability than the stock market has given them.
Wednesday, March 10, 2010
Financial Chaos
John M. Templeton
Lyford Cay, Nassau, Bahamas
June 15, 2005
MEMORANDUM
Financial Chaos – probably in many nations in the next five years. The word chaos is chosen to express likelihood of reduced profit margin at the same time as acceleration in cost of living.
Increasingly often, people ask my opinion on what is likely to happen financially. I am now thinking that the dangers are more numerous and larger than ever before in my lifetime. Quite likely, in the early months of 2005, the peak of prosperity is behind us.
In the past century, protection could be obtained by keeping your net worth in cash or government bonds. Now, the surplus capacities are so great that most currencies and bonds are likely to continue losing their purchasing power.
Mortgages and other forms of debts are over tenfold greater now than ever before 1970, which can cause manifold increases in bankruptcy auctions.
Surplus capacity, which leads to intense competition, has already shown devastating effects on companies who operate airlines and is now beginning to show in companies in ocean shipping and other activities. Also, the present surpluses of cash and liquid assets have pushed yields on bonds and mortgages almost to zero when adjusted for higher cost of living. Clearly, major corrections are likely in the next few years.
Most of the methods of universities and other schools which require residence have become hopelessly obsolete. Probably over half of the universities in the world will disappear quickly over the next thirty years.
Obsolescence is likely to have a devastating effect in a wide variety of human activities, especially in those where advancement is hindered by labor unions or other bureaucracies or by government regulations.
Increasing freedom of competition is likely to cause most established institutions to disappear with the next fifty years, especially in nations where there are limits on free competition.
Accelerating competition is likely to cause profit margins to continue to decrease and even become negative in various industries. Over tenfold more persons hopelessly indebted leads to multiplying bankruptcies not only for them but for many businesses that extend credit without collateral. Voters are likely to enact rescue subsidies, which transfer the debts to governments, such as Fannie May and Freddie Mac.
Research and discoveries and efficiency are likely to continue to accelerate. Probably, as quickly as fifty years, as much as ninety percent of education will be done by electronics.
Now, with almost one hundred independent nations on earth and rapid advancements in communication, the top one percent of people are likely to progress more rapidly than the others. Such top one percent may consist of those who are multi-millionaires and also, those who are innovators and also, those with top intellectual abilities. Comparisons show that prosperity flows toward those nations having most freedom of competition.
Especially, electronic computers are likely to become helpful in all human activities including even persons who have not yet learned to read.
Hopefully, many of you can help us to find published journals and websites and electronic search engines to help us benefit from accelerating research and discoveries.
Not yet have I found any better method to prosper during the future financial chaos, which is likely to last many years, than to keep your net worth in shares of those corporations that have proven to have the widest profit margins and the most rapidly increasing profits. Earning power is likely to continue to be valuable, especially if diversified among many nations.
Lyford Cay, Nassau, Bahamas
June 15, 2005
MEMORANDUM
Financial Chaos – probably in many nations in the next five years. The word chaos is chosen to express likelihood of reduced profit margin at the same time as acceleration in cost of living.
Increasingly often, people ask my opinion on what is likely to happen financially. I am now thinking that the dangers are more numerous and larger than ever before in my lifetime. Quite likely, in the early months of 2005, the peak of prosperity is behind us.
In the past century, protection could be obtained by keeping your net worth in cash or government bonds. Now, the surplus capacities are so great that most currencies and bonds are likely to continue losing their purchasing power.
Mortgages and other forms of debts are over tenfold greater now than ever before 1970, which can cause manifold increases in bankruptcy auctions.
Surplus capacity, which leads to intense competition, has already shown devastating effects on companies who operate airlines and is now beginning to show in companies in ocean shipping and other activities. Also, the present surpluses of cash and liquid assets have pushed yields on bonds and mortgages almost to zero when adjusted for higher cost of living. Clearly, major corrections are likely in the next few years.
Most of the methods of universities and other schools which require residence have become hopelessly obsolete. Probably over half of the universities in the world will disappear quickly over the next thirty years.
Obsolescence is likely to have a devastating effect in a wide variety of human activities, especially in those where advancement is hindered by labor unions or other bureaucracies or by government regulations.
Increasing freedom of competition is likely to cause most established institutions to disappear with the next fifty years, especially in nations where there are limits on free competition.
Accelerating competition is likely to cause profit margins to continue to decrease and even become negative in various industries. Over tenfold more persons hopelessly indebted leads to multiplying bankruptcies not only for them but for many businesses that extend credit without collateral. Voters are likely to enact rescue subsidies, which transfer the debts to governments, such as Fannie May and Freddie Mac.
Research and discoveries and efficiency are likely to continue to accelerate. Probably, as quickly as fifty years, as much as ninety percent of education will be done by electronics.
Now, with almost one hundred independent nations on earth and rapid advancements in communication, the top one percent of people are likely to progress more rapidly than the others. Such top one percent may consist of those who are multi-millionaires and also, those who are innovators and also, those with top intellectual abilities. Comparisons show that prosperity flows toward those nations having most freedom of competition.
Especially, electronic computers are likely to become helpful in all human activities including even persons who have not yet learned to read.
Hopefully, many of you can help us to find published journals and websites and electronic search engines to help us benefit from accelerating research and discoveries.
Not yet have I found any better method to prosper during the future financial chaos, which is likely to last many years, than to keep your net worth in shares of those corporations that have proven to have the widest profit margins and the most rapidly increasing profits. Earning power is likely to continue to be valuable, especially if diversified among many nations.
Monday, March 1, 2010
Stocks for growth and Bonds for Income
For many years we have been taught that our investments should be split between stocks and bonds. Stocks for growth, and bonds for income.
With extreme volatility in the stock markets in recent years and record low interest rates on bonds, many investors have questioned their asset mix.
Investors are increasingly looking for alternative income-generating investments, that give more than the meager returns on bonds and GIC's and greater stability than the stock market has given them.
REITs are a way of getting a decent way to earn income and protect capital. However, stocks may be the income vehicle of the future.
With extreme volatility in the stock markets in recent years and record low interest rates on bonds, many investors have questioned their asset mix.
Investors are increasingly looking for alternative income-generating investments, that give more than the meager returns on bonds and GIC's and greater stability than the stock market has given them.
REITs are a way of getting a decent way to earn income and protect capital. However, stocks may be the income vehicle of the future.
Sunday, February 28, 2010
Investing for Income is Still Your Best Strategy
The big driver of investment returns over time is not figuring which sector is going to be best, or which country is going to be best, or which style is going to be best over the next year or three – the big driver is income and the reinvestment of income.
The baby boom generation is now retiring (or attempting to retire) and will begin to take a closer look at their investments ability to generate income without liquidating their portfolio.
I still maintain that you must begin building a income portfolio as early as possible. My retirement account presently generates over $3,000 a month in income and I am still in my early fifties.
Every asset in my account generates an income.
I started this strategy in my mid forties. I wish I would have started earlier.
The baby boom generation is now retiring (or attempting to retire) and will begin to take a closer look at their investments ability to generate income without liquidating their portfolio.
I still maintain that you must begin building a income portfolio as early as possible. My retirement account presently generates over $3,000 a month in income and I am still in my early fifties.
Every asset in my account generates an income.
I started this strategy in my mid forties. I wish I would have started earlier.
Saturday, October 3, 2009
Cash Flow Generating Securities
One of my personal favorites is calculating the Net Present Value/Breakeven point for a stock that pays a stable dividend stream. This metric actually has relevance because the dividend is a cash payment that comes directly to the investor as a consequence of owning the shares. In the short-term, dividends are a known quantity. Obviously the metric only applies in the case where a dividend is paid. In the case where an investor is focusing on dividend investing for income purposes or simply for generating the maximum cash from their investing capital, these are important considerations.
An example is on order. Let’s say that an investor purchases 100 shares of a stock trading at $10/share that pays a $1/share annual dividend. The dividend yield on his investment is 10%. The P/Div ratio is 10. This means that the investor paid $10 for every dollar in dividends. Now the nice thing about dividends is that they are cash streams and we can use some common time value of money calculations to make determinations as to whether or not to invest. Let’s use the 100 shares as an example and do a net present value calculation with the following assumptions:
•Our time horizon is 25 years
•Dividends over the 25 years will average the current $1/year
•The Cost of Capital (COC or inflation) will be 6%/year for the duration of the exercise
Most popular spreadsheet programs contain the NPV function where you can set your COC and the value of the individual cash flows if you desire to perform this analysis for yourself.
The Net Present Value of this situation is $262.58, giving a positive indication or a ‘buy’ signal. This alone should not be used to make a buy determination, but should be used as a tool to validate or invalidate individual investment opportunities that arose from our analyses in parts I and II.
The Time to Cover or Breakeven point of this hypothetical investment is Year 15. What this means is that after 15 years, the dividends (after accounting for the deterioration in value due to inflation) will cover the cost of the initial investment. Whatever the investment itself is worth at that time is added value. So even if our stock is still at $10/share, it is paid for, we’re in the clear, making dividends for another 10 years before we need the funds, and can sell the stock at any time thereafter for a pure profit. And since inflation has already been figured in, we’re talking about real gains. We can easily modify the analysis to accommodate hypothetical taxation circumstances as well. Another important point may also be made from the above analysis. Considering that we’re getting $1/year in dividends, in nominal terms, the Time to Cover/Breakeven would be 10 years. Inflation at a rate of 6% per annum increased the breakeven point by 50% or 5 years. While 6% doesn’t seem like that much, this example illustrates exactly how much of a burden on wealth it represents. If anyone really wants to see why clipping bond coupons isn’t such a hot idea, run this analysis on the 30-year Treasury Bond and it will become immediately obvious.
Moving forward, when looking at dividend paying investments, we are looking for lower P/Div ratios (higher yields), and consequently lower Time to Cover/Breakeven points. While looking at the yield gives some good insight, using the NPV and breakeven analysis allows us to quantify the deleterious effects of inflation over time. The yield alone doesn’t give us that ability since it is a snapshot in time and changes as the price of the underlying security changes. It is important to note that in this study, we are NOT valuing the firm. We are valuing the cash streams that the firm pays to shareholders and discounting them to the present.
The risks to the above analysis are obviously many. 25 years is a long period of time, and things can change dramatically. Firms can go out of business or eliminate dividend payments thereby rendering the above effort worthless. Also, the major types of risk such as market, currency, political, and systemic cannot be accounted for over such a long period of time. This is one of the reasons why it is never a good idea to buy today and walk away. Successful investing is a journey, not a destination. As soon as you think you’ve got it all figured out, that is when you’ll get bitten. Vigilance is the name of the game. Another obvious takeaway here is that we’re dealing with long term investing, not trading. Such studies are a moot point for the short-term trader since their focus is on a different goal. Realize I am not trying to be impertinent towards traders, but simply pointing out the difference between their objectives and those of long-term investing.
An example is on order. Let’s say that an investor purchases 100 shares of a stock trading at $10/share that pays a $1/share annual dividend. The dividend yield on his investment is 10%. The P/Div ratio is 10. This means that the investor paid $10 for every dollar in dividends. Now the nice thing about dividends is that they are cash streams and we can use some common time value of money calculations to make determinations as to whether or not to invest. Let’s use the 100 shares as an example and do a net present value calculation with the following assumptions:
•Our time horizon is 25 years
•Dividends over the 25 years will average the current $1/year
•The Cost of Capital (COC or inflation) will be 6%/year for the duration of the exercise
Most popular spreadsheet programs contain the NPV function where you can set your COC and the value of the individual cash flows if you desire to perform this analysis for yourself.
The Net Present Value of this situation is $262.58, giving a positive indication or a ‘buy’ signal. This alone should not be used to make a buy determination, but should be used as a tool to validate or invalidate individual investment opportunities that arose from our analyses in parts I and II.
The Time to Cover or Breakeven point of this hypothetical investment is Year 15. What this means is that after 15 years, the dividends (after accounting for the deterioration in value due to inflation) will cover the cost of the initial investment. Whatever the investment itself is worth at that time is added value. So even if our stock is still at $10/share, it is paid for, we’re in the clear, making dividends for another 10 years before we need the funds, and can sell the stock at any time thereafter for a pure profit. And since inflation has already been figured in, we’re talking about real gains. We can easily modify the analysis to accommodate hypothetical taxation circumstances as well. Another important point may also be made from the above analysis. Considering that we’re getting $1/year in dividends, in nominal terms, the Time to Cover/Breakeven would be 10 years. Inflation at a rate of 6% per annum increased the breakeven point by 50% or 5 years. While 6% doesn’t seem like that much, this example illustrates exactly how much of a burden on wealth it represents. If anyone really wants to see why clipping bond coupons isn’t such a hot idea, run this analysis on the 30-year Treasury Bond and it will become immediately obvious.
Moving forward, when looking at dividend paying investments, we are looking for lower P/Div ratios (higher yields), and consequently lower Time to Cover/Breakeven points. While looking at the yield gives some good insight, using the NPV and breakeven analysis allows us to quantify the deleterious effects of inflation over time. The yield alone doesn’t give us that ability since it is a snapshot in time and changes as the price of the underlying security changes. It is important to note that in this study, we are NOT valuing the firm. We are valuing the cash streams that the firm pays to shareholders and discounting them to the present.
The risks to the above analysis are obviously many. 25 years is a long period of time, and things can change dramatically. Firms can go out of business or eliminate dividend payments thereby rendering the above effort worthless. Also, the major types of risk such as market, currency, political, and systemic cannot be accounted for over such a long period of time. This is one of the reasons why it is never a good idea to buy today and walk away. Successful investing is a journey, not a destination. As soon as you think you’ve got it all figured out, that is when you’ll get bitten. Vigilance is the name of the game. Another obvious takeaway here is that we’re dealing with long term investing, not trading. Such studies are a moot point for the short-term trader since their focus is on a different goal. Realize I am not trying to be impertinent towards traders, but simply pointing out the difference between their objectives and those of long-term investing.
Wednesday, August 26, 2009
Will Oil Be the Last Asset Standing?
Stocks and commodities gained last week while the dollar – as is often the case these days – fell.
As you recall from last week's update, the correlation between these three assets has unusually close. The see-saw today has stocks and commodities on one side and the dollar on the other.
Investors must ask themselves how long this party can continue, and which of these assets they should be left holding when it ends.
To be perfectly honest, when the party ends it will probably end for all three assets, with stocks, commodities, and the dollar all losing value. However, while all three will go down, only some will be down for the count...
THE RESILIENCE OF OIL
Leaving aside the dollar for the moment, let's focus on stocks and one key commodity, oil.
Our feeling is that oil prices have greater staying power over the long-term than stock prices. Unless you just walked in the door, you won't be surprised to hear us say that. But let's look at two of our most important reasons.
Right now, increased demand for oil stems from the part of the world where economic growth is highest – the emerging economies and especially China.
(Recently someone argued that Chinese growth is not really sustainable because the Chinese consumer accounts for only a small part of China's economy. We disagree that this situation constrains the economy. Chinese consumers are starting to step up their purchasing. We've seen a huge jump in Chinese auto sales for instance, to the level where they surpassed the car sales in the U.S. And retail figures suggest that the Chinese consumer is becoming more of a leader than a follower.)
Overall, Chinese industrialization, infrastructure building, and the rise of its consumer should prevent any collapse in oil demand.
On the other side of the equation, oil production is unlikely to overtake demand unless oil prices rise dramatically. Right now, producers need a minimum oil price of $70 a barrel to justify investing in new production.
And a temporary spike above $70 (like we have now) won't cut it. If anything, producers need to feel confident that $70 will be the bottom of oil's price range for the foreseeable future.
Given oil's huge spike and subsequent plunge in 2008, oil will need to get a lot more expensive and stay expensive for quite a while before producers get brave enough to start bringing new supplies online.
If oil prices fall back to under $70, oil supplies will remain at a level where they cannot keep up with even lackluster economic growth. Eventually, the world would not have enough oil available to increase production of other commodities or manufactured goods. With a fixed or even declining oil supply, Americans and other Westerners would have to consume less – gallon per gallon – in order for China and the emerging world to consume more.
And that's not a scenario anyone wants to see (especially since the developing world would win the contest).
Bottom line: we need oil prices to remain above $70 to sustain any growth whatsoever.
Meanwhile, U.S. consumers have problems of their own. They have sustained a serious blow, in the form of a $13 trillion drop in their collective net worth, which has them focused on saving more and spending less for the first time in decades. Under these conditions, higher commodity prices will act as a tax, giving consumers even more reason to stop spending. Eventually, it will hold back U.S. economic growth too.
How high can oil prices go before they start to impact economic growth? Actually, it's a question of both price and time. If oil prices remain in the mid-$70s between now and the end of December 2009, that would do it. It would mean we had a year-over-year increase of more than 80% - the level at which our Long Term Master Key would issue a “sell” signal on the overall stock market.
We are betting that oil (and commodities in general) will have more staying power as this scenario unfolds than stocks. Oil is in a cyclical uptrend whereas stocks are trapped in a trading range. However, you should know that both groups will decline in the short-term if that signal is reached.
By now, you may be wondering, “What do we do in the meantime?”...
FOLLOWING THE IRRATIONAL HERD
All we can say for now is that today's market is irrational to be following a path in which both stocks and commodities rise together. It's also irrational to see the most speculative, high risk stocks such as AIG or Fannie Mae accounting for the lion's share of market volume. Yet this has been the case on many recent trading days.
However, markets can stay irrational for some time. All we can expect, while we're waiting for the correction, is that the market leaders will continue to lead. Despite the incredible risks in today's economy the “high beta” (high risk) stocks may continue to outperform.
So if you are impatient and want to make some gains while waiting for the music to stop here's what to do...
First, hold on to gold and zero coupon bonds as a hedge for when the correction comes. Same with the conservative defensive/offensive stocks we mentioned last week.
With that protection in place, and only to the extent of your risk tolerance, you can pursue gains among our high beta choices. Our recommendations here are long-term keepers. Even though they could come down hard in a correction, they are also likely to lead the market in the meantime. They include:
Potash (POT) and Mosaic (MOS), the world's two leading fertilizer producers.
Fluor (FLR), the world's leading engineering and construction company, which will benefit from any drive to raise energy supplies.
Intel (INTC) and Apple (AAPL) as Information Technology plays.
Oil service companies, such as Transocean (RIG), Nabors (NBR), Schlumberger (SLB), and National Oilwell Varco (NOV).
While these stocks will surely decline when the overall market tanks, they are still good stocks to own for the long haul, as they are set to dramatically outperform the market that’s destined to be erratic in the foreseeable future. And with our recommended hedges in place, you should get through the decline, when it comes, in much better than average shape.
As you recall from last week's update, the correlation between these three assets has unusually close. The see-saw today has stocks and commodities on one side and the dollar on the other.
Investors must ask themselves how long this party can continue, and which of these assets they should be left holding when it ends.
To be perfectly honest, when the party ends it will probably end for all three assets, with stocks, commodities, and the dollar all losing value. However, while all three will go down, only some will be down for the count...
THE RESILIENCE OF OIL
Leaving aside the dollar for the moment, let's focus on stocks and one key commodity, oil.
Our feeling is that oil prices have greater staying power over the long-term than stock prices. Unless you just walked in the door, you won't be surprised to hear us say that. But let's look at two of our most important reasons.
Right now, increased demand for oil stems from the part of the world where economic growth is highest – the emerging economies and especially China.
(Recently someone argued that Chinese growth is not really sustainable because the Chinese consumer accounts for only a small part of China's economy. We disagree that this situation constrains the economy. Chinese consumers are starting to step up their purchasing. We've seen a huge jump in Chinese auto sales for instance, to the level where they surpassed the car sales in the U.S. And retail figures suggest that the Chinese consumer is becoming more of a leader than a follower.)
Overall, Chinese industrialization, infrastructure building, and the rise of its consumer should prevent any collapse in oil demand.
On the other side of the equation, oil production is unlikely to overtake demand unless oil prices rise dramatically. Right now, producers need a minimum oil price of $70 a barrel to justify investing in new production.
And a temporary spike above $70 (like we have now) won't cut it. If anything, producers need to feel confident that $70 will be the bottom of oil's price range for the foreseeable future.
Given oil's huge spike and subsequent plunge in 2008, oil will need to get a lot more expensive and stay expensive for quite a while before producers get brave enough to start bringing new supplies online.
If oil prices fall back to under $70, oil supplies will remain at a level where they cannot keep up with even lackluster economic growth. Eventually, the world would not have enough oil available to increase production of other commodities or manufactured goods. With a fixed or even declining oil supply, Americans and other Westerners would have to consume less – gallon per gallon – in order for China and the emerging world to consume more.
And that's not a scenario anyone wants to see (especially since the developing world would win the contest).
Bottom line: we need oil prices to remain above $70 to sustain any growth whatsoever.
Meanwhile, U.S. consumers have problems of their own. They have sustained a serious blow, in the form of a $13 trillion drop in their collective net worth, which has them focused on saving more and spending less for the first time in decades. Under these conditions, higher commodity prices will act as a tax, giving consumers even more reason to stop spending. Eventually, it will hold back U.S. economic growth too.
How high can oil prices go before they start to impact economic growth? Actually, it's a question of both price and time. If oil prices remain in the mid-$70s between now and the end of December 2009, that would do it. It would mean we had a year-over-year increase of more than 80% - the level at which our Long Term Master Key would issue a “sell” signal on the overall stock market.
We are betting that oil (and commodities in general) will have more staying power as this scenario unfolds than stocks. Oil is in a cyclical uptrend whereas stocks are trapped in a trading range. However, you should know that both groups will decline in the short-term if that signal is reached.
By now, you may be wondering, “What do we do in the meantime?”...
FOLLOWING THE IRRATIONAL HERD
All we can say for now is that today's market is irrational to be following a path in which both stocks and commodities rise together. It's also irrational to see the most speculative, high risk stocks such as AIG or Fannie Mae accounting for the lion's share of market volume. Yet this has been the case on many recent trading days.
However, markets can stay irrational for some time. All we can expect, while we're waiting for the correction, is that the market leaders will continue to lead. Despite the incredible risks in today's economy the “high beta” (high risk) stocks may continue to outperform.
So if you are impatient and want to make some gains while waiting for the music to stop here's what to do...
First, hold on to gold and zero coupon bonds as a hedge for when the correction comes. Same with the conservative defensive/offensive stocks we mentioned last week.
With that protection in place, and only to the extent of your risk tolerance, you can pursue gains among our high beta choices. Our recommendations here are long-term keepers. Even though they could come down hard in a correction, they are also likely to lead the market in the meantime. They include:
Potash (POT) and Mosaic (MOS), the world's two leading fertilizer producers.
Fluor (FLR), the world's leading engineering and construction company, which will benefit from any drive to raise energy supplies.
Intel (INTC) and Apple (AAPL) as Information Technology plays.
Oil service companies, such as Transocean (RIG), Nabors (NBR), Schlumberger (SLB), and National Oilwell Varco (NOV).
While these stocks will surely decline when the overall market tanks, they are still good stocks to own for the long haul, as they are set to dramatically outperform the market that’s destined to be erratic in the foreseeable future. And with our recommended hedges in place, you should get through the decline, when it comes, in much better than average shape.
Saturday, July 25, 2009
Views of a Contrary Investor
I see discussions of short term percentage gain or loss in investing all the time. I rarely see similar long term discussions. Important? Maybe not. But is the fact that there is simple asymmetry between percentage gains and losses actually considered? If it really was, I think a fair number of investors would change their thinking, at least a bit.
If you invest for two years, one up 10% and one down 10% (either order) you end up losing 1%. If you had twice the variability (up 20%, down 20%), you end up losing 4%. If you have a real rollercoaster ride like we’ve had recently and have a +40% and -40% year, you end up losing 16%. And that’s just in a two year time frame. Over a couple decades or so, this is no small matter.
Here’s a different example. Suppose you had five and a half years in which you had an annual return of +24%. But you also had 4 years of -30% performance. 5.5 years compared to 4 years is a bigger ratio than 30% to 24%, so it could look close to a wash on first blush. Actually you’d end up with a loss of 36%. I didn’t pick these numbers randomly. They’re the combined rates of return for the two cyclical bull and two cyclical bear cycles for the S&P 500 in the current secular bear market (counting the last 4+ months as the second bull cycle) since March 2000. For retirees the loss is even worse because nearly a decade has been lost too, and there’s much less time to make it up.
It’s been noted that there’s a fine line between investing and gambling. It’s also been noted that gamblers as a whole notoriously inaccurately report their betting results. This is true even though they know the games are all rigged and casinos very consistently report gaming profits. I’m only suggesting that there’s a psychological driver that can keep us from being objective when it comes to some numbers.
Focus on the short term is the name of the game for TA. It can work well, until it doesn’t. The trends and indicators traders use can be useful for the well informed, and there are people making a lot of money using it. But it’s a combination of skill and getting more right calls than wrong ones, because technicals simply change at some point and go in another direction. They always do that at some point whenever they have been going in a direction for some time that the fundamentals aren’t going in. Ironically, the longer term you use in TA the better the predictive power. I recall seeing a discipline using the 20 and 50 week moving avg. which would only involve trading every few years. It actually resulted in very few bad signals.
But if you go out to the very long term, you can find very durable trends that you can use to guide you. The problem of course is that all of this takes a lot of patience. I suspect, more than anything else, the gambling/investing crossover has some merit here. Gambling is done to make money quickly or at least to have fun. The most successful long term investors tell us success comes with patience and discipline. Now there’s a conflict.
The most useful long term trend I know about is the two century pattern of secular market oscillation. The characteristics of the trend are that the length is fairly uniform, and the investment results over for the opposing cycles are hugely different. In other words you could reliably make money for years during one phase of the cycle and avoid most of the loss in the other phase of the cycle. But very few people have any interest in this phenomenon and it basically gets ignored.
The other very useful long term trend I know of is the fact that the variance in performance of a given security is due much more to the variance of its asset class than its individual characteristics. And the variance in performance of a given asset class is much more due to the variance in the economic fundaments than characteristic differences from other classes. So the greatest bang for the DD buck in the long run is to learn about the big things. This too is pretty unappealing. None of this is any fun. And it takes too long to get any results.
A knowledge of secular market history and characteristics would put a lot of beliefs and myths into a better perspective IMO. We live and work in a shorter time frame, and get our expectations conditioned accordingly. In the last secular bull market (1982-2000), the only cyclical bear market was the very brief one because of the 1987 crash. 17 plus years of bull market and a few months of bear market. Everybody was making money, especially the risk takers. But to a lesser extent, the same thing was true of the prior secular bull market (1949 – 1966) – 15 years of bull market and only 2 yrs. of bear market.
But the secular bear markets are a long tough grind, which have the added characteristic of being cruel because there is actually more bull market time in them than bear market time. In the intervening secular bear market (1966 – 1982), there was 6.7 yrs. of cyclical bear market but 9.7 years of cyclical bull market.
Maybe surprisingly, the compound annual growth rate for the bear years was almost the mirror image of the bull years (-21% vs. +20%). But as you might guess the result wasn’t a real gain because of how percentages work against you. Actually the overall CAGR was about +0.6%. But there’s nothing positive about 17 years of almost no nominal gain in the face of rapidly rising inflation. Real gain was distinctly negative.
Even in the current secular bear market (2000- present), there has been the 5.5 years I mentioned of cyclical bull market and “only” a bit under 4 years of cyclical bear market. Small consolation, and again cruel, as cyclical thinking still has investors with a shorter term outlook anticipating a fairly timely recovery of the lost ground.
A few years ago I posted in other places a number of times about my deep concern with the long term investing environment we were in. I took some real criticism for being so conservative and being satisfied with trying to earn no more than an 8% return while the domestic equity market was turning out a 14% gain.
I have nothing that isn’t obvious to suggest as a way to achieve good long term results.. But here goes. It really does take more to make up a loss than it took to make it the first time, so don’t lose it. The best investment advisors are the ones with the longest experience. Pay attention to the big picture, even study it. Of course the real world consists of an overwhelming number of market participants with a short term outlook, people trying to make money quickly, and most of the attention focused on bottom up thinking. This is after all a post from a contrarian investor.
joatmon
If you invest for two years, one up 10% and one down 10% (either order) you end up losing 1%. If you had twice the variability (up 20%, down 20%), you end up losing 4%. If you have a real rollercoaster ride like we’ve had recently and have a +40% and -40% year, you end up losing 16%. And that’s just in a two year time frame. Over a couple decades or so, this is no small matter.
Here’s a different example. Suppose you had five and a half years in which you had an annual return of +24%. But you also had 4 years of -30% performance. 5.5 years compared to 4 years is a bigger ratio than 30% to 24%, so it could look close to a wash on first blush. Actually you’d end up with a loss of 36%. I didn’t pick these numbers randomly. They’re the combined rates of return for the two cyclical bull and two cyclical bear cycles for the S&P 500 in the current secular bear market (counting the last 4+ months as the second bull cycle) since March 2000. For retirees the loss is even worse because nearly a decade has been lost too, and there’s much less time to make it up.
It’s been noted that there’s a fine line between investing and gambling. It’s also been noted that gamblers as a whole notoriously inaccurately report their betting results. This is true even though they know the games are all rigged and casinos very consistently report gaming profits. I’m only suggesting that there’s a psychological driver that can keep us from being objective when it comes to some numbers.
Focus on the short term is the name of the game for TA. It can work well, until it doesn’t. The trends and indicators traders use can be useful for the well informed, and there are people making a lot of money using it. But it’s a combination of skill and getting more right calls than wrong ones, because technicals simply change at some point and go in another direction. They always do that at some point whenever they have been going in a direction for some time that the fundamentals aren’t going in. Ironically, the longer term you use in TA the better the predictive power. I recall seeing a discipline using the 20 and 50 week moving avg. which would only involve trading every few years. It actually resulted in very few bad signals.
But if you go out to the very long term, you can find very durable trends that you can use to guide you. The problem of course is that all of this takes a lot of patience. I suspect, more than anything else, the gambling/investing crossover has some merit here. Gambling is done to make money quickly or at least to have fun. The most successful long term investors tell us success comes with patience and discipline. Now there’s a conflict.
The most useful long term trend I know about is the two century pattern of secular market oscillation. The characteristics of the trend are that the length is fairly uniform, and the investment results over for the opposing cycles are hugely different. In other words you could reliably make money for years during one phase of the cycle and avoid most of the loss in the other phase of the cycle. But very few people have any interest in this phenomenon and it basically gets ignored.
The other very useful long term trend I know of is the fact that the variance in performance of a given security is due much more to the variance of its asset class than its individual characteristics. And the variance in performance of a given asset class is much more due to the variance in the economic fundaments than characteristic differences from other classes. So the greatest bang for the DD buck in the long run is to learn about the big things. This too is pretty unappealing. None of this is any fun. And it takes too long to get any results.
A knowledge of secular market history and characteristics would put a lot of beliefs and myths into a better perspective IMO. We live and work in a shorter time frame, and get our expectations conditioned accordingly. In the last secular bull market (1982-2000), the only cyclical bear market was the very brief one because of the 1987 crash. 17 plus years of bull market and a few months of bear market. Everybody was making money, especially the risk takers. But to a lesser extent, the same thing was true of the prior secular bull market (1949 – 1966) – 15 years of bull market and only 2 yrs. of bear market.
But the secular bear markets are a long tough grind, which have the added characteristic of being cruel because there is actually more bull market time in them than bear market time. In the intervening secular bear market (1966 – 1982), there was 6.7 yrs. of cyclical bear market but 9.7 years of cyclical bull market.
Maybe surprisingly, the compound annual growth rate for the bear years was almost the mirror image of the bull years (-21% vs. +20%). But as you might guess the result wasn’t a real gain because of how percentages work against you. Actually the overall CAGR was about +0.6%. But there’s nothing positive about 17 years of almost no nominal gain in the face of rapidly rising inflation. Real gain was distinctly negative.
Even in the current secular bear market (2000- present), there has been the 5.5 years I mentioned of cyclical bull market and “only” a bit under 4 years of cyclical bear market. Small consolation, and again cruel, as cyclical thinking still has investors with a shorter term outlook anticipating a fairly timely recovery of the lost ground.
A few years ago I posted in other places a number of times about my deep concern with the long term investing environment we were in. I took some real criticism for being so conservative and being satisfied with trying to earn no more than an 8% return while the domestic equity market was turning out a 14% gain.
I have nothing that isn’t obvious to suggest as a way to achieve good long term results.. But here goes. It really does take more to make up a loss than it took to make it the first time, so don’t lose it. The best investment advisors are the ones with the longest experience. Pay attention to the big picture, even study it. Of course the real world consists of an overwhelming number of market participants with a short term outlook, people trying to make money quickly, and most of the attention focused on bottom up thinking. This is after all a post from a contrarian investor.
joatmon
Tuesday, July 21, 2009
Low Price for Natural Gas May be Just What is Needed
The low price for natural gas may be just what is needed to expand markets in the transportation and electric generation sector.
Instead of pouring printed money into uneconomic alternative energy, American political leaders could have Government Motors apply its efforts to building vehicles to run on the proven technology of clean natural gas. Utility executives can make the easy choice of simply running natural gas through generating capacity already in place rather than agonizing over the expense and political uncertainty of new coal and nuclear capacity.
While natural gas cannot meet all the transportation and electric generation needs entirely at once, there appears to be the capacity to supply all of the expected growth and more. Considering that $3 a gallon gasoline is equivalent to $24 a million btu natural gas there is ample room for the price of natural gas to rise and still be a bargain for consumers.
Instead of pouring printed money into uneconomic alternative energy, American political leaders could have Government Motors apply its efforts to building vehicles to run on the proven technology of clean natural gas. Utility executives can make the easy choice of simply running natural gas through generating capacity already in place rather than agonizing over the expense and political uncertainty of new coal and nuclear capacity.
While natural gas cannot meet all the transportation and electric generation needs entirely at once, there appears to be the capacity to supply all of the expected growth and more. Considering that $3 a gallon gasoline is equivalent to $24 a million btu natural gas there is ample room for the price of natural gas to rise and still be a bargain for consumers.
Sunday, July 19, 2009
Gartman calls the end of the recession "official"
THE DOLDRUMS HAVE STRUCK BUT THE
YEN AND THE US$ CONTINUE GENERALLY
Firstly, let us turn our attention to the chart at the
bottom left this page of weekly jobless claims. Clearly
now they have “spiked” lower. We were willing to
“give” the weakness in claims last week some room for
seasonal problems attendant to the closing of various
auto plants around the country and to the July 4th
holiday itself.
Obviously now, after another week
has passed and the weakness of the previous
week was followed hard upon by even greater
weakness… even greater “spikiness,” we’ve
concluded that this is indeed the sign we’ve
needed to officially call for the end of the current
recession… and so we are making that call.
The recession has ended. In light of the spike in
jobless claims AND in light of the recent upward
turn in the Ratio of the Coincident to Lagging
Indicators, we are making this statement as
clearly and as unequivocally as we are able to
make one. The recession is over. The worst of the
economic news shall all soon be behind us.
Make no mistake about this, however, it will be
months… even perhaps a year or more… before the
NBER meets and officially decides that the recession
has ended. Our long standing clients will recall that in
late ’04 when the Ratio turned down we said that
history mandated that we call for a recession sometime
in ’07 and we stood by that statement time and time
and time again, even to the point of being laughed at.
When jobless claims began to rise in mid-’07, we went
on record stating that the recession was only months
away… again to laughter. Finally, when Chinese
stocks first broke from their highs and when the US
stock market began to show clear signs of weakening
in late ’07, we said that the recession had begun…
always to derision by others.
Eventually, however, the NBER said that our views were the proper views and
that the US economy had indeed entered recession in
late ’07. They did not make that statement officially,
however, until only quite recently, more than a year
after the recession really had begun.
The recession is now over. But do not expect the
economic data to reflect that fact for many, many
months into the future. Unemployment is still going to
rise and rise dramatically. Indeed, we’ve every belief
that unemployment will not top out until it has touched at least
10% and we’ll not be surprised to see it “trade” to 11% or even
12% before its bull run is finished.
Too, we can expect retail sales to be very hard to
forecast for the next several months, for the consumer
remains distraught and concerned about his/her future.
In that environment, any propensity to ramp up spending
will swiftly meet head-on with continued rising propensities to save. Until the employment “stats” turn for the better, consumer spending stats will follow to
the downside. Such is the historic nature of things
economic, and despite the SEC’s, the NFA’s, the
NASD’s and FINRA’s admonitions that past performance is not indicative of future performance, in the economy the past is indeed prologue to the future.
In the future, given that it was housing and autos that
took us into recession, we’ll be brave and say that it
shall be housing and autos that take us out.
So long as the population here in the US continues to grow… and
it will unless Americans have chosen to give up sex,
which we doubt; and unless the Congress moves to
enact legislation that will clamp down upon
immigration, which it may do but which we fervently
hope it will not do; so go sit down and be quiet, Mr.
Buchanan and Mr. Dobbs! Please!!... we cannot live for
long with housing starts reported each month to be at
annualised rates of less than 0.7 million units. Too, the
average automobile in the US is growing very old and
the entire fleet is going to need replacement sooner
rather than later.
We have said before and we shall say
again that we’ll l soon have shortages of housing and
perhaps even shortages of autos. Again, that’s the
nature of things as the empiricist economists project
recent trends years into the future and forecast no
demand, while we know that all things economic ebb
and flow, moving from shortage to over-production and
to shortage again.
In this light we note that housing starts for June will be
reported this morning and they will be down, despite
our “call” above for the end of the recession. As our
clients will remember, starts rose smartly in May, but
we must see the May increase in its proper light: in
historical terms this supposedly 17% increase
from the April lows was a mere mote in the eye o
the downward trend in place since mid’06 when
starts topped-out just above 2.0 million
annualised units. 2.0 million annualised starts
for any protracted period of time is unsustainable.
That has been proven time and time and time again
over the past fifty years, and starts of less than 0.5
million are also unsustainable. We are there now.
Starts will turn for the better sooner rather than later.
The lows very probably were made in April, but the
new uptrend in starts will not be evident until such time
as we see something above 0.7 million annualised
units and the monthly data rushes upward through the
6 month moving average noted in the chart this page.
The consensus is looking for today’s starts figure to be
somewhere near .53 million annualised starts and we’ll
not argue with that “guess-timate” too loudly. We’d like
to see something above 0.6 million, but we won’t… not
until next month perhaps.
To this end, we’ll keep a much close watch in the
coming months on the building permits figures, for
permits always lead actual starts. Permits, however,
are horribly erratic because just because a permit is
issued does not mean that a “start” must start. The
consensus is looking for permits to be up a bit from the
May figure, calling for something close to 0.55 million
units. We’ve no reason to argue; we’ll await the actual
number however… it might be interesting.
Finally, regarding housing, the supply of new homes
for sale was recently reported at 10.2 months, down
from the record high of 12.4 months January, but far,
far above the 4 or 5 month supply that was the norm
back in the earlier part of this decade. This onerous
supply of new homes will be worked off before builders
shall have the confidence to begin building again…
and long before the nation’s banks will even consider
lending on building again!
This latter concern is probably the most important concern, for without
lending the entire industry is tainted. Banks will lend
when banks lend; it is that simple. Bankers will wait
until the other banker down the street has chosen to
act, and once the new process of lending to real estate
turns it will turn swiftly. It will be as if the present
problems were wholly forgotten, despite the promises
otherwise. Banking has always been thus; it shall
always be thus. Anyone want to bet otherwise?... We
thought not:
To make our final point, the NAHB homebuilder index
was reported out on Wednesday, rising 2 points to 17.
This index is like that of the ISM: it ranges between 0-
100, with 50 as the growth/no growth point. A figure
above 50 means the industry is strengthening; a
number below 50 means it is shrinking.
At 17 the industry is clearly still shrinking but up from 15 it means
that the shrinking is proceeding at lesser pace. This is
not then a “green shoot.” It is rather than the old shoots
are withering less quickly. “Green-ness” lies some way
into the future, but it will come. For the building
industry, at the moment, the line from “A Field of
Dreams” is turned around. Rather than “If you build it
[they] will come,” it is instead “If they come, it will be
built.”
YEN AND THE US$ CONTINUE GENERALLY
Firstly, let us turn our attention to the chart at the
bottom left this page of weekly jobless claims. Clearly
now they have “spiked” lower. We were willing to
“give” the weakness in claims last week some room for
seasonal problems attendant to the closing of various
auto plants around the country and to the July 4th
holiday itself.
Obviously now, after another week
has passed and the weakness of the previous
week was followed hard upon by even greater
weakness… even greater “spikiness,” we’ve
concluded that this is indeed the sign we’ve
needed to officially call for the end of the current
recession… and so we are making that call.
The recession has ended. In light of the spike in
jobless claims AND in light of the recent upward
turn in the Ratio of the Coincident to Lagging
Indicators, we are making this statement as
clearly and as unequivocally as we are able to
make one. The recession is over. The worst of the
economic news shall all soon be behind us.
Make no mistake about this, however, it will be
months… even perhaps a year or more… before the
NBER meets and officially decides that the recession
has ended. Our long standing clients will recall that in
late ’04 when the Ratio turned down we said that
history mandated that we call for a recession sometime
in ’07 and we stood by that statement time and time
and time again, even to the point of being laughed at.
When jobless claims began to rise in mid-’07, we went
on record stating that the recession was only months
away… again to laughter. Finally, when Chinese
stocks first broke from their highs and when the US
stock market began to show clear signs of weakening
in late ’07, we said that the recession had begun…
always to derision by others.
Eventually, however, the NBER said that our views were the proper views and
that the US economy had indeed entered recession in
late ’07. They did not make that statement officially,
however, until only quite recently, more than a year
after the recession really had begun.
The recession is now over. But do not expect the
economic data to reflect that fact for many, many
months into the future. Unemployment is still going to
rise and rise dramatically. Indeed, we’ve every belief
that unemployment will not top out until it has touched at least
10% and we’ll not be surprised to see it “trade” to 11% or even
12% before its bull run is finished.
Too, we can expect retail sales to be very hard to
forecast for the next several months, for the consumer
remains distraught and concerned about his/her future.
In that environment, any propensity to ramp up spending
will swiftly meet head-on with continued rising propensities to save. Until the employment “stats” turn for the better, consumer spending stats will follow to
the downside. Such is the historic nature of things
economic, and despite the SEC’s, the NFA’s, the
NASD’s and FINRA’s admonitions that past performance is not indicative of future performance, in the economy the past is indeed prologue to the future.
In the future, given that it was housing and autos that
took us into recession, we’ll be brave and say that it
shall be housing and autos that take us out.
So long as the population here in the US continues to grow… and
it will unless Americans have chosen to give up sex,
which we doubt; and unless the Congress moves to
enact legislation that will clamp down upon
immigration, which it may do but which we fervently
hope it will not do; so go sit down and be quiet, Mr.
Buchanan and Mr. Dobbs! Please!!... we cannot live for
long with housing starts reported each month to be at
annualised rates of less than 0.7 million units. Too, the
average automobile in the US is growing very old and
the entire fleet is going to need replacement sooner
rather than later.
We have said before and we shall say
again that we’ll l soon have shortages of housing and
perhaps even shortages of autos. Again, that’s the
nature of things as the empiricist economists project
recent trends years into the future and forecast no
demand, while we know that all things economic ebb
and flow, moving from shortage to over-production and
to shortage again.
In this light we note that housing starts for June will be
reported this morning and they will be down, despite
our “call” above for the end of the recession. As our
clients will remember, starts rose smartly in May, but
we must see the May increase in its proper light: in
historical terms this supposedly 17% increase
from the April lows was a mere mote in the eye o
the downward trend in place since mid’06 when
starts topped-out just above 2.0 million
annualised units. 2.0 million annualised starts
for any protracted period of time is unsustainable.
That has been proven time and time and time again
over the past fifty years, and starts of less than 0.5
million are also unsustainable. We are there now.
Starts will turn for the better sooner rather than later.
The lows very probably were made in April, but the
new uptrend in starts will not be evident until such time
as we see something above 0.7 million annualised
units and the monthly data rushes upward through the
6 month moving average noted in the chart this page.
The consensus is looking for today’s starts figure to be
somewhere near .53 million annualised starts and we’ll
not argue with that “guess-timate” too loudly. We’d like
to see something above 0.6 million, but we won’t… not
until next month perhaps.
To this end, we’ll keep a much close watch in the
coming months on the building permits figures, for
permits always lead actual starts. Permits, however,
are horribly erratic because just because a permit is
issued does not mean that a “start” must start. The
consensus is looking for permits to be up a bit from the
May figure, calling for something close to 0.55 million
units. We’ve no reason to argue; we’ll await the actual
number however… it might be interesting.
Finally, regarding housing, the supply of new homes
for sale was recently reported at 10.2 months, down
from the record high of 12.4 months January, but far,
far above the 4 or 5 month supply that was the norm
back in the earlier part of this decade. This onerous
supply of new homes will be worked off before builders
shall have the confidence to begin building again…
and long before the nation’s banks will even consider
lending on building again!
This latter concern is probably the most important concern, for without
lending the entire industry is tainted. Banks will lend
when banks lend; it is that simple. Bankers will wait
until the other banker down the street has chosen to
act, and once the new process of lending to real estate
turns it will turn swiftly. It will be as if the present
problems were wholly forgotten, despite the promises
otherwise. Banking has always been thus; it shall
always be thus. Anyone want to bet otherwise?... We
thought not:
To make our final point, the NAHB homebuilder index
was reported out on Wednesday, rising 2 points to 17.
This index is like that of the ISM: it ranges between 0-
100, with 50 as the growth/no growth point. A figure
above 50 means the industry is strengthening; a
number below 50 means it is shrinking.
At 17 the industry is clearly still shrinking but up from 15 it means
that the shrinking is proceeding at lesser pace. This is
not then a “green shoot.” It is rather than the old shoots
are withering less quickly. “Green-ness” lies some way
into the future, but it will come. For the building
industry, at the moment, the line from “A Field of
Dreams” is turned around. Rather than “If you build it
[they] will come,” it is instead “If they come, it will be
built.”
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