THIS IS MY 185TH BLOG ON UNDERSTANDING MONEY
TOOLS
March, 2020
In this chapter/tutorial we are going to cover several
things. It’s going to be a discussion
on several business topics, taking a format of students asking various
questions. Some of this will
be my opinion based upon research, and some will just be very well supported
facts that I believe you should know.
To keep this more concise let’s go back to a question and answer
format. Try to answer the
questions yourself before the given answer. I hope you enjoy this.
It is quite lengthy, so you may want to read it in portions.
- Question: Currently the hot news topic is the
Coronavirus, where did it come from?
Will there be an antidotal for the virus? What effect to the markets?
- Answer: From what I read the virus was lab
produced in China. Did it derive
from a snake or bat? I doubt it. Experiments may have been done on
bats. Many labs have produced
“bad” things dating far back. When
Nazi, Dr. Josef Mengele, was experimenting on inmates during WWII the US and
others were also experimenting with bacteria, dating to the 1930s. Biological
warfare has been going on worldwide, and may get out of control from labs. With the spread of the virus it will
definitely have an effect on corporate earnings, thus stock market
results. This will be widespread
especially products made in China, the tourist industry, the airline industry
and more. As the virus was apparently man-made we should have an anti-dote
before long but the medicine will take time to pass the Federal Drug
Administration (FDA) and be mass-produced.
- Question: What are the various parts of a
business cycle?
- Answer: Expansion, peak, contraction and
trough.
- Question: What is the normal time frame for this cycle?
- Answer: From 1945 until 2009, according to the
government, it is 5-1/2 years.
- Question: How long has the most recent expansion
gone? And, why?
- Answer: According to the government we have
been in expansion mode since The Great Recession (2008-2010). This is due to government intervention
into business, stock markets, banks and the printing of money.
- Question: I thought we were a “free market”,
capitalistic economy? This sounds
like Socialism or Fascism?
- Answer: So true. We all know what Socialism is, and Fascism existed well into
the 1970s as in Spain when General Franco ruled. With Fascism the government takes an interest in businesses
as we did during The Great Recession with banks and also corporations like
General Motors Corp.
- Question: Why are the stock markets so high today
in relationship to past history?
- Answer: Quite simply money. There is a total disconnect between
corporate earnings and stock prices.
Now, we look at where the money comes from. The US government has pumped trillions of dollars into the
markets since The Great Recession and especially since Mr. Trump took
office. Federal Reserve Chairman,
Jerome Powell, stated “we will do everything to avoid a recession”. This includes newly printed money into
the markets. (From my findings this includes about $2.5 trillion since the
obvious weakening of the markets in late September, 2019.) Secondly, corporations have been
borrowing money or using their earnings to buy their own stock back and,
thirdly corporate human resource departments encouraging employees to buy their
company’s stock every two weeks in pension programs including 401’s. (Many of you do not remember the 2000
financial debacle with Enron Corp.
Ken Lay, the Chairman and CEO of Enron, touted his corporation
encouraging his employees to invest all they could in the company while he knew
it was deteriorating, resulting in a $70 billion bankruptcy and employees
losing their money. Ken “lucked
out” dying of a major heart attack in 2006 before he had to go to prison!)
- Question: I mention the Feds pumping trillions
into the markets, how much since the Great Recession?
- Answer: From the facts I receive and from
reliable sources, as of December 25, 2019 it was $4.165 trillion, off balance
sheet. Then, as of February 12, 2020 it went up to $4.173 trillion and before
the end of February it was at $4.182 trillion.
- Question:
Is it prudent in today’s market to buy stocks with no earnings, or low
earnings?
- Answer: In my opinion, no. Look at buying a stock as if you were
using your money to buy an entire company. Would you personally buy a company that loses money in a
risky, over priced market? Let’s
take a smart investor who has made a ton of money like Warren Buffett and his
company, Berkshire Hathaway.
Warren bought over $500 million of Kroger stock in 4th
quarter 2019. I like Kroger
stock. It is a “staple
stock”. In other words if times
get tough you still need to eat food.
Kroger’s price to earnings ratio is 12:1, very reasonable. Mr. Buffett also owns a lot of Coca
Cola, another staple stock. He
owns 400 million shares. Another
strategy is buy large blocks of stock in solid companies versus getting too
spread out, and not staying on top of things in operations and finances.
- Question: I refer to markets being too high and
not “free market”. Is this true?
- Answer: Yes, and for a long time. The manipulation of markets, versus
free markets has caused an extraordinary and disproportionate pricing to
historic real value. In reference,
take the DOW Industrials. The
current price to earnings ratio, even with the February sell-off, is 29 to 1; historically should be 14 or
15 to 1. Therefore, the market
today is 100% overpriced.
- Question: Can I tell when the government is in
the markets buying?
- Answer: Yes, and quite simply. When you have down days followed
immediately by days correcting the market for stabilization. You will notice irregular trading
patterns.
- Question: Would it be prudent to buy bonds or
stocks now?
- Answer: There are no guarantees in life. The safest is a money market or cash in
a large bank. Bond yields are
incredibly low, however for the most part, depending on the type (corporate,
municipal government, US Government), relatively safe. I would say start selecting the highest quality stocks for
dividends. We are in a “correction”
cycle. In the business cycle there
is the “trough” or bottom. Hard to
decide on when to enter the market, especially with the Coronavirus
situation. Wait to see how the
current situation plays out. We
could easily drop 40% to 50% more to equate to where a normal market value
should be.
- Question: Should a person have the same
investment philosophy or paradigm through their entire life?
- Answer: No. Above I mention “person”. If you are a company or fund, perhaps yes. For the young individual who has good
earning ability you may want to take more risk with stocks and perhaps a few
back up bonds or even an annuity.
This is referred to as “Asset Allocation”. (Annuities are high commission products for the most part
and I avoid them with the exception of a guaranteed minimum return like Met
Life has, or had.) As a person
ages re-balance your portfolio to risk according to age with more conservative
stocks and income producing instruments like bonds. With bonds “ladder” the maturity dates so they mature at
different timeframes.
- Question: Wouldn’t the Coronavirus be a good
excuse for the government to blame for downturns in markets?
- Answer: I would think so. The next corporate earnings report will
indicate how we are doing financially; I expect earnings and projected earnings
to be down, and yet stock prices may be up. Remember it is a political election year and there may be government
intervention.
- Question: A friend recently stated that his son
sold stock “after hours” and made more money on the stock than when the New
York Stock Exchange closed that given day. How was this possible?
- Answer: You can go to “after hours” trading. All the big investment banking firms
have offices around the world in different time zones. Trading occurs all over the world.
- Question:
What is the difference between a “round lot” trade of stock and “odd” lot?
- Answer: A round lot is an even number of shares
based upon 100. An odd lot number
would be some fraction of 100.
Sometimes a commission on an odd lot trade may be higher because it is
more difficult to find a buyer who wants an odd number of shares.
- Question: I remember years ago companies split
their stock every time a stock increased to around $100/share, why not now?
- Answer: Times change. Years back most buying and selling of securities was by
individuals. Companies wanted to
keep their stock price within a range where most people could afford a “round
lot” of at least 100 shares.
Today, people invest through funds like Vanguard and Fidelity that are
institutional investors, therefore not price sensitive. The institutions are making the
investments.
- Question: Why would the investment firm Morgan
Stanley be willing to pay about $13 billion for low priced trading company, E
Trade?
- Answer: Two reasons; to control future market
share with new clients, and low cost trading companies are profitable. You must remember that even though a
company can be low cost on each trade, trading is done on a “bid/ask”
basis. This is referred to as the
“spread”. There is a lot of room
here, in many cases, to add extra costs and profit. This could be equated to an auto dealership where they tell
you that you can buy a car at $100 over cost. This is their cost with administration added in, dealer
rebates from manufacturer not disclosed, etc. They are making considerable
profit.
- Question: The US bond interest yields hit 30 year
lows the last week in February.
Why is Mr. Trump encouraging lower rates to even negative rates like in
Germany, Japan and the Netherlands?
- Answer: The 10 year US bond yields about
1.5%. In Germany their bond is
called the “Bund” and as of February 26th Bloomberg News reported
the 2 year bond at negative .71% and their 10 year bond at negative .51%. People are running for safety. The bond market, like most markets, is
about supply and demand. If people
are leaving the stock markets for safety and going to cash and bonds, interest
rates fall. This is the disconnect
I talk about with our stock market.
It should be falling in a corrective mode to reality, however has not. Now, think why our bonds are still
positive while these other countries are not. It has to do with our governmental stability in view of the
world. We have an extraordinary
amount of private sector and government debt. Germany and the Netherlands have little or no debt. If a government bond is negative you
actually pay to buy the bond. With the US, if we had a negative rate the
government can print more money, sell more bonds and make money!
- Question: You hear about FAANG stocks. What are they and what proportion of
capitalization do they hold in the stock markets?
- Answer: FAANG stands for Facebook, Apple,
Amazon, Netflix and Google. From
my researching, they stand for about 18% of the total stock market value. If times get tough usually companies
that have few tangible assets come down quickest, and these stocks are way over
priced!
I hope you enjoyed this tutorial.
