The surreality in the world today makes it difficult to
address investment and economic issues outside the parameters of the oligarchic
dystopia that trump and Putin are conspiring to make of our country. The West wins the Cold War after more than 40
years of great sacrifice, both in lives and money. And in two years, peace and
stability are being tossed back into the abyss of anarchy and strong man rule. One
would expect this from a Russian dictator, not an American president.
Later in this letter we will discuss investing fundamentals
that the Author Rob started with in the early 1990s and used to build his
knowledge base to day trade and trade options. This should be helpful advice to
assist you in your savings goals and retirement plans.
But first, some bad omens…
FEARS OF AN INVERTED
YIELD CURVE
An inverted yield curve is a situation where the short-term
interest rates rise converge with long-term interest rates. In a normal
interest rate environment, long-term interest rates are higher than short-term
interest rates. The reasons are straightforward. If I have a thousand dollars
to loan, my money faces at least two risks. First, I am tying up my money for a
defined period of time. And I am
incurring opportunity costs. If my friend invites me to join her in a great
business idea, I am unable to do so for the term of the loan. If another party
offers a better interest rate, that opportunity is also lost.
Secondly, I am taking an inflationary risk. Interest rates
factor in many things, including default risk and inflation. If I loan money
for a year at three percent and inflation spikes to five percent, I am hosed.
The interest I receive will not even cover the devaluation of my principal. High
inflation is bad for consumers because they must pay more for good and
services. High inflation is especially bad for savers and lenders because it
decreases the real value of their capital and savings.
CAUSES AND EFFECTS OF
AN INVERTED YIELD CURVE
As we know, interest on longer-term loans should be higher
than on short-term loans. So what causes the yield curve to invert?
In a normal banking, business, or economic cycle, lenders
borrow money at a lower interest rate for short-term rates to lend money for
longer periods of time at a higher interest rate. (When bank customers deposit
their money in banks they are effectively lending the bank money at the “going”
interest rate for a short term loan.) The difference between the lower
short-term interest rate and the higher long-term rate is the “spread,” or the
lender’s profit.
Yield curves invert when central banks (Federal Reserve)
intervene to raise interest rates. The Federal Reserve has at least four tools
to raise interest rates.
The decision to raise interest rates is made by the Federal
Open Market Committee. The Fed generally
raises interest rates when the economy is beginning to overheat and inflation
looms. At times the Fed is very anticipatory, sometimes a little more
reactionary. If we look at the last few years of Fed activity, intervention to
raise interest rates were somewhat moderate.
The Fed has raised interest rates twice this year and has
indicated that it will raise rates twice more. This is at least moderate
anti-inflationary intervention. Trump, in commenting on Fed moves and ignoring
the long history of Fed independence, said:
“"I'm not thrilled" about the
Fed's interest rate hikes. "Because we go up, and every time you go up,
they want to raise rates again. I don't really — I am not happy about it. But
at the same time, I'm letting them do what they feel is best."
trump, nor any other president, has any ability or tradition of dictating the
activity of the Fed. (If the president could drive Fed activity, the president
would go ZIRP* or NIRP*, put the economy on steroids to be reelected, and then
lame duck it out with a severe recession.) In fact, trump’s untoward comments
are in contravention of presidential precedent and signal an ignorance of the
relationship between the Fed and the executive branch.
RECESSION
ON THE HORIZON
Perhaps more important than the
Author’s ruminations on the cause of the inverted yield curve is the effect.
Seven of the last seven inverted yield curves have been followed by recessions.
Here is why:
First, when interest rates invert,
banks stop lending. If short term rates to attract capital are higher, or close
to the long-term rates, the spread is gone and so is the profit.
Secondly, inverted yield curves often
incur when the economy is moving from deep recession to robust recovery. This triggers inflation, which is a risk to
the economy. The 1970s saw some double-digit inflation in the US and the West.
Not a pleasant experience.
The economy has been recovering since
2009. It is beginning to overheat and the Fed is attempting to contain that
growth with measured interest rate increases. But containment has its own risk,
that of cyclical recession.
OH, AND ONE MORE THING…
A factor that will make a recession more likely is trump’s ill-advised trade war against our allies and trading partners. As stated in Forbes Magazine in a June 4, 2018 article entitled “Top Business Economists Predict U.S. Could FaceRecession in 2020” it states:
“One of the biggest causes for the decline according to the economists are Trump’s current trade policies; three-fourths of the panelists predict that Trump’s imposed tariffs on steel and aluminum imports from the Canada, Mexico, and the European Union, as well as tariffs on Chinese imports, will trigger a global trade war as the nations look to retaliate.”
NOW SOME BETTER NEWS (OR AT LEAST IT CAN BE BETTER NEWS)
Despite healthy stock market gains over the last 10 years, the gains have not been widely shared. An article from the August 3, 2017 issue of the Chicago Tribune lays it out clearly:
“Nearly half of country has $0 invested in the market, according to the Federal Reserve and numerous surveys by groups such as Gallup and Bankrate. That means people have no money in pension funds, 401(k) retirement plans, IRAs, mutual funds or ETFs. They certainly don't own individual stocks such as Facebook or Apple."
This is doubly bad news. Not only do half of Americans not own stock, but also they have little to no money saved for retirement.
So what can folks do about this? Learning how to invest in the stock market is a skill that anyone with average intelligence and diligence can develop. And you do not have to be wealthy to do it. It can be done on a modest budget.
Here is one of the best ways to do it.
Better Investing (National Association of Investment Corporation) offers a wealth of resources to individual investors and investment clubs. It publishes a monthly magazine, Better Investing, and has a full array of online tools. Membership is inexpensive at $22 per year and trial memberships are available. The core tool is the Stock Selection Guide, a document to analyze sales growth, management effectiveness, earnings growth, risk and reward and develop a five-year price estimate. When the Author started in the early 1990s, these Stock Selection Guide forms were filled out with pencil, calculator and a ruler with data from loose leaf Value Line or S&P reports. Now they are automated. Filing out a few on paper is a good idea to begin, however. A new investor will learn the internal workings of the Stock Selection Guide tool and understand the information that they present.
The Better Investing methodology seeks out growth stocks that are fairly values or undervalued and have good growth potential. GARP (Growth At a Reasonable Price.) The methodology is fundamental analysis, a skill that every new investor should develop before moving on to other methodologies such as technical analysis, options trading or other advance techniques. As former NFL Vikings coach Mike Tice said, “You have to learn the trade first. Then you can work on the tricks of the trade.”
But that is only one-half of what beginning investors need. They need to be able to invest small amounts of money in a small portfolio of stocks. This is where DRIPs come in.
DRIPs (Dividend Reinvestment Plans) allow investors to begin investing in a stock with as little as one share and permit small periodic contributions. Also, the dividends are reinvested to purchase more stock. Better Investing contains links to DRIPs and many brokers offer DRIP plans for certain stocks.
A good initial DRIP strategy is to target an investment portfolio of five stocks. In the ordinary course of things, three stocks will behave as you have predicted. One will perform much better than you foresaw, and one will do worse. Not an ironclad rule, but a good rule of thumb.
DON’T SAY WE NEVER GAVE YOU ANYTHING IN THE DESERT OF THE REAL!
*(NIRP) means Negative Interest Rate
Policy is a rare policy to address a severe recession. (ZIRP) means Zero Interest
Rate Policy is a policy that keeps rates close to zero, a situation that Japan
found itself in.
