THIS IS MY 162ND BLOG ON UNDERSTANDING MONEY
TOOLS
March, 2019
In the last blog we looked at practical business ideas. In this blog let’s look at practical
and basic understandings to stock market values. To understand this in simple terms let’s proceed in a
question and answer format.
- Question:
What are the four stages of a business cycle?
- Answer:
Expansion, peak, correction and trough.
- Question:
How long do most business cycles last in their growth stage?
- Answer:
6 years. It is dependent on Gross
Domestic Product.
- Question:
How long has our current growth cycle lasted?
- Answer:
About 10 years.
- Question:
Why has the last business cycle lasted so long?
- Answer:
Keynesian Economics entered in, versus free market. A manipulation of money policy to artificially control
growth through easy lending policies.
This was reflected by our national debt going from $10 to $20 trillion
during President Obama years in office.
- Question:
Where are we in the normal business cycle?
- Answer:
Mixed opinions. I believe because
we are far overextended on a time cycle basis, and the GDP dropping fairly
consistently over the past 6 months (projected to go lower) that we have
reached our business peak and in the correction or contraction stage.
- Question:
What do interest rates have to do with stock market valuations?
- Answer:
Quite a bit. Interest rates are
controlled by Central Banks. Our
Central Bank is the Federal Reserve.
The Federal Reserve historically “over-does things”. We have had 4 interest rate increases,
supposedly to slow the economy and prevent inflation above 2.5%. The other reason, and perhaps more to
the point, is to create a strong dollar so that we can sell bonds (debt) to pay
our bills and keep our government in business.
- Question:
So bonds are debt. What do we look
for that will correlate to the stock markets?
- Answer:
Debt kills! My old expression, but
true. We can never pay off our
debt, perhaps never again break-even.
In a normal “free market” interest rates and bond yields are the first
indicators to market corrections.
We have had an “inversion curve” on bond rates starting a year ago. An inversion curve is a predecessor to
a recession. To define, it means
that short term bond yields (interest rates) rise faster than long term yields,
perhaps crossing over. E.g. our 10
year yield exceeded our 30 year yield...until the Feds intervened once again. In the first couple of weeks of March
the Feds needed to sell approximately $40 billion in bonds to raise money. The world buyers are becoming cautious
and viewing our unsustainable debt and losses. Therefore, to sell this amount of debt we needed to raise
the interest rate 9 basis points to meet the market. (One percent is 100 basis
points). This doesn’t sound like
much until you are attempting to raise billions of dollars!
- Question:
The US trade deficit hit an all time high ending 2018 of $891 billion, is this
important?
- Answer:
Yes, very important. It means that
we are importing and buying $891 billion worth of merchandise more than we are
exporting and selling abroad. This
amount of money is deducted when calculating GDP, and furthermore money that
will never come back to this country.
- Question:
Why do we need to concern ourselves over the financial health of other
countries in the world?
- Answer: We are global economy. If other countries can’t afford our
exports we need to be able to sell within this country, and we can’t sell
enough merchandise, thus GDP would go down. If countries weaken which buy our debt (bonds) like China,
Japan and Saudi Arabia we are in trouble.
This would place the burden upon US citizens, and most do not have money
to invest to that magnitude.
- Question:
What is a liquid asset test and quick ratio test?
- Answer: They are the same and have been used
for years to determine the health of a company; a benchmark. Basically, it is the ratio between net
assets and net liabilities of a given company. The old ratio standard was 2 to 1. With all the corporate borrowing and debt this has
changed. Will corporations be able
to pay their bank loans and bonds?
- Question: What is momentum trading?
- Answer: Years ago investment companies and
investors based their decisions on
financial analysis. With the
advent of computers, technology software and paradigms, “momentum” has become a
trading standard versus analysis.
Investment firms may trade millions of dollars in stock over momentum
upward or downward in a stock, and hold the position for fractions of a
second. Many funds and wealthy
people have moved their finances off-shore to avoid taxation. Money will not return. Investment firms now just want to make
money, and are not concerned with long-term versus short-term capital gains
taxation.
- Question:
We have drummed in that 15:1 price to earning ratios is the standard, resulting
in a 6.5% return on investment.
Does this still hold?
- Answer:
I fault our investment fundamentals consistently over this, however perhaps we
entered a new era where nothing matters.
It is all about making money quickly and propping up individual
retirement accounts and health of our overall economy, albeit false. The price to earnings ratio is higher
with the NASDAQ or Russell 2000 as it is made up more from high tech companies,
and values are based upon suppositions of growth or “projected price per
earnings ratios”.
- Question:
Should we watch “who” is buying or selling a company’s stock?
- Answer:
Yes, definitely. The main thing to
watch here besides volume is insider trading of officers and board members.
These people know what is going on in a company. If they are buyers, good; sellers, watch out, as something
may be amiss. In the last few
years companies have been borrowing money cheaply from Wall Street, issuing
bonds and buying their own stock, thus raising the market price of the stock.
- Question:
What are the “moving day averages”, and why is that important?
- Answer:
You will find this represented as 50 day, 100 day, and 200 day moving averages. It should reflect upon the health and
interest in a company’s stock, and trend.
Volume in buying or selling of a stock is very important.
- Question:
Is it important to know the manager of a particular fund?
- Answer:
The manager, not the fund or company, is all-important. That’s the horse you are putting your
money on! We had the position that
if a fund changed their manager we normally pulled our money out.
- Question:
Is it better to go with an investment manager or index or exchange fund? (An index fund is a select sector
of stocks like Energy, Financials that include banks, or Utilities. An exchange fund is explanatory; the
NYSE, NASDAQ, etc. composites.)
- Answer:
Again, in 2018 it proved that exchange traded funds (ETF’s) did just as well,
if not better, than if you went with a money manager. Historically they have tested this against a chimpanzee, and
the chimp won.
- Question: Why were stocks less expensive to buy
per share, e.g. in the $10-$50 range 25 to 50 years ago than today?
- Answer: Main reasons. One, back 25 years ago funds were not as popular as they are
today, therefore individuals took responsibility for buying their investments,
and we used stockbrokers. Today,
about 85% of all investing is through institutions like “funds” and investment
banking firms. Two, for the norm,
price to earnings ratios were considerably lower than today. Three, years back companies wanted
stock prices to be at a level that most people could afford. Most stock purchases are in the 100
share amount, “odd lots” are anything other. Big companies like Walgreens, GE, Motorola would let the
market take their stock values up to around $80/share and then split in some
ratio, 2:1, 3:1, thus opening up the market to more people who could afford a
100 share purchase. In today’s
institutional market we see outrageous pricing e.g. Amazon at $1,712./share and
Warren Buffett’s Berkshire Hathaway at $307,250./share. Institutions can afford these prices.
I don’t trust numbers.
It depends on the source for information, and you will get all sorts of
numbers. If you are looking at
P/E’s (price of stock to earnings per share), they vary greatly. For instance, if you look at the NASDAQ
the report may give you only the NASDAQ 100, or top 100 stocks listed,
therefore a 23:1. The entire
NSADAQ, I believe, is around 60:1.
Another example is the DOW Jones P/E. On March 15, 2019 I went to two sources, The Wall Street
Journal and a source I use that runs calculations to “current time”. At day’s end I compared the two. The Wall Street Journal had the DOW P/E
at 19:1 and my source stated 27.38:1 (to the one hundredth of a point!) Perhaps The Wall Street Journal
calculated using PPE, or a “projected price to earnings ratio” for the future. Looks better! The lower the P/E the
better an investment will be. You can go to various sources for these figures
that should be a constant, and they are not.
In the past couple of years the government permitted changes
to the “General Accounting Practices” (GAP), or “General Accounting Principles
and Practices” (GAPP) which reflects better net earnings. Also, in 2018 the government dropped
the corporate tax rate from 35% to 21% for a high, which improves net earnings.
This should give you some ammunition for analysis and
understanding practicalities for stocks and markets
