Quarters, dimes, and bitcoins

Bitcoins have soared to nearly $3,000 apiece at a speed that most certainly is the tragic arc of a bubble. When is the best time to buy a currency? When it’s new or, at the very least, extraordinarily cheap. Here’s a small example.

Back in the Cretaceous period – ok, 1964 – the government announced that dimes and quarters, then 90% silver, would be made of copper coated with nickel, starting in 1965. (Half dollars of 40% silver were minted until 1970.)

Image result for standing liberty quarterWhile the government had changed coin design from time to time, it hadn’t fiddled with the composition of silver coinage before. In 1964, it wasn’t uncommon to find silver standing Liberty quarters in your pocket. They were a beautiful coin designed by sculptor Hermon Atkins MacNeil and were minted from 1916 through 1930. They were replaced by the familiar Washington quarter.

My mother, at the time, saved as many silver quarters and dimes as she could: I still have them. Coin dealers call them “junk silver,” because they are too worn to have any real value as collectibles. Nevertheless, they are 90% silver. How did they fare as an investment?

Not too badly. As of June 10, each silver quarter would be worth $3.11, if you melted it down and sold it for its silver content. That’s a gain of 1,144% over the years, handily beating the 691% cumulative rise in inflation since 1964.

We certainly weren’t in a position to stash gold coins. My mom was a high-school secretary, and my dad was a government worker. Also,  the U.S. didn’t make gold coins, and hadn’t since the Great Depression. And private ownership of gold was illegal until January 1, 1975.

One could argue that we could have done better in the stock market, and that’s true, with one itty-bitty problem: Most stock investments available to the public were pretty awful, laden with outrageous fees and commissions. The Vanguard 500 Stock Index fund was just a twinkle in Jack Bogle’s eye. (As a side note: The fund’s current $3,000 minimum initial investment was the equivalent of $23,577 back in 1964).

One big boost to silver’s price, at least in 1964, was that the government had a significant interest in keeping silver prices low: If silver broke $1.29 an ounce, the Treasury would face a wave of redemptions from silver certificates. At $1.29 an ounce, people could melt their silver coins and sell them at a profit. (As an interesting historical fact, U.S. silver coins had ridges, or reeding, on their edges so you can tell if people have shaved a bit off the side. The tradition continued through the later, less valuable copper-nickel coins.) In any event, the government was the main player in the silver market, and so we acquired our silver at an artificially low price.

While Bitcoin may be in its infancy, it’s by no means cheap, especially since it has no intrinsic value. You can melt your silver and make a nice sculpture, if you’re so inclined, Image result for frankensteinor use it for weird electrical experiments. Even dollars, while primarily an intellectual construct, have the backing of the U.S. government and every other government in the world, at least indirectly.

Back in 2011, you could have bought a bitcoin for $1. After a brief surge to $31, bitcoins fell back to $2. By design, the number of bitcoins is limited, so at least in theory, they will retain some of their value – unless, of course, a new shiny internet object comes about. And at the moment, there are about 100 cryptocurrencies available. I can’t imagine people collecting them. At least with my dimes and nickels, I can think of my mother and smile.

Bitcoin: What could possibly go wrong?

Bitcoin prices reached a new high today of $2,700 per bitcoin. What could possibly go wrong?

It’s hard to know where to start, but the parabolic arc of the bitcoin chart is one place. Spikes like this rarely end well. Here’s today’s bitcoin:

Look familiar? Here’s the Nasdaq during its halcyon days.

Of course, there are other reasons to fret about the rapid rise in value of something that has no earnings or dividends, as many of the tech wreck’s biggest failures did. One is the increasing cost of mining bitcoins. To create a Bitcoin, you have to use massive computing power to solve mathematical puzzles. The process is fairly succinctly laid out in this useful story: 

“Bitcoins are mined by getting lots of computers around the world to try and solve the same mathematical puzzle. Every ten minutes or so, someone solves the puzzle and is rewarded with some bitcoins. Then, a new puzzle is generated and the whole thing starts over again.”

The difficulty of the new puzzle — and the electrical cost of finding the answer — depends on demand. Back in May 2015, the bitcoin network ran on about 343 megawats, or enough to power about a third of the homes in San Jose, Calif. in May 2015.  Another estimate put the cost of mining one bitcoin at the same rate as running an average home for 1.57 days. (Bitcoins are granted in blocks, rather than individually).

Back then, a bitcoin was worth about $650. You can find out the current cost of mining bitcoins here.

Aside from the rising costs of mining bitcoins, there’s the theft problem. The problem with untraceable currency is that, well, it’s untraceable. Once it’s gone, it’s pretty much gone. And like many things stored on computers, bitcoins are vulnerable to hacking, as the 2014 theft of $700 million in bitcoins from Mt. Gox demonstrated.

Why invest in bitcoin? I honestly can’t imagine. If you’re thinking that government-issued money is going to go away, it’s hard to imagine bitcoin transactions in the smoking rubble of civilization. (As a friend of mine noted, it would probably be better to have a few things to trade, like food or wine). And it’s hard to imagine that governments will long tolerate alternative currencies. And bitcoin certainly doesn’t seem to be immune to bubbles. I hope you are.

Update: That was fast. Bitcoin’s down 9% today. 

Media preview

Thanks to Business Insider for the two charts, and the smart reporting.

Cheap won’t always save you

I keep hearing that emerging markets are historically cheap, and that if you don’t like the high stock valuations in the U.S., you should add emerging markets to your portfolio. There are lots of reasons to add emerging markets, but being a panacea for high U.S. prices is not one of them, as I explain in my most recent column for InvestmentNews.

Provide, provide

Sooner or later, the nation’s eye will turn to Social Security. Advocates of reducing benefits say, “We can’t afford it.” The question then becomes “Can afford it?”

The average monthly Social Security benefit is $1,348, or $16,176 a year. That’s not much, and Social Security was never meant to be a full-blown pension. On the other hand, Social Security is a vital part of most retirees’ lives.

Ida May Fuller, first recipient of Social Security.

According to the government, 48% of married couples and 71% of unmarried persons receive half or more of their income from Social Security.  Twenty-one percent of married couples and 43% of unmarried people rely on Social Security for 90% or more of their income.

Social Security has two features that are particularly important to retirees. First, it’s a guaranteed lifetime income. Your Social Security payments last as long as you do.

Second, Social Security payments are protected against inflation, which is the enemy of anyone who lives on a fixed income. The effects of inflation are cumulative: After 10 years of 3% inflation, a $1,348 payment has the buying power of $10,148 – a 24% decline.

If the nation no longer wants to fully support Social Security in its present form, you will have to make up the slack. And it’s not cheap.

How much money would you need to replace the average Social Security payout? We can get a rough indication from the annuity industry. When you buy a basic immediate annuity, you get an insurance company’s guarantee of income for life, just as you do from Social Security. An immediate annuity is a bet with the insurance company. If you get hit by the 9:15 southbound Cannonball Express a week after you buy the annuity, the insurance company keeps your money and you lose. If you live to 115 while smoking cigars and drinking whiskey, the insurance company pays out more than you invested, and you win.

Most annuities aren’t adjusted for inflation. The Vanguard Group does offer an annuity whose payout raises 3% a year – roughly the inflation rate since 1926. To get a monthly starting payout of $1,300, here’s what a person born in Pennsylvania on 3/8/1952 would need:

 

Female life only $256,960.37
Female life only with 2% graded payment $317,264.07
Female life only with 3% graded payment $355,450.39
Male life only $240,346.76
Male life only with 2% graded payment $293,254.43
Male life only with 3% graded payment $326,409.49

Male policies are cheaper because we die earlier than women. It’s just the way it is.

Bear in mind that Social Security offers other benefits, such as disability payments and payments to surviving family members.

The bottom line: Let’s say you were counting on an income of $50,000 in retirement, and that $16,000 of that was from Social Security. Conventional wisdom says that you can only safely withdraw 5% of your investment kitty each year if you want to adjust your payout for inflation. To get $34,000 a year in investment income, then, you’d need $680,000. To make up for the loss of Social Security, you’d have to add another $326,000 to $355,000.

No one is talking seriously about abolishing Social Security – which, as a reminder, has its own stream of tax revenue for funding. But every reduction in benefits means that you have to make up for it. Provide, provide!

Lots of cash and animal spirits: What could possibly go wrong?

If you’ve ever been to a particularly raucous New Year’s party, you know that there’s a logical progression from the first awkward arrivals and introductions until you’re sleeping in a car full of raccoons and empty Cheetos bags.  And, at the time, each step makes wonderful sense.

Right now, the markets are at a spot where spirits are high and cash is flowing like liquor at your broker’s annual Christmas party. Let’s take a look at the animal spirits first.

University of Michigan, University of Michigan: Consumer Sentiment© [UMCSENT], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/UMCSENT, January 1, 2017.

 University of Michigan, University of Michigan: Consumer Sentiment© [UMCSENT], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/UMCSENT, January 1, 2017.

As you can see, consumer sentiment has been rising since the dark days of 2009; it now stands at 98.2 — the chart is lagged by a month. Sentiment is now higher than it was in January 2015 (98.1), and the highest since February 2004.

Soptimism-graphmall business confidence is also up post-recession, but it jumped markedly after the election, presumably on the hopes of lower taxes and regulation by the new administration.

And that confidence — plus the 12% gain by the Standard & Poor’s 500 stock index this year — has sparked optimism among investors. The American Association of Individual Investors sentiment survey now stands at 45.6% bullish, vs. its 38.5% historical average. Similarly, just 25.7%  of those surveyed said they were bearish, vs. a historical average of 30.5%. Bullish sentiment is at a five-week high, and its third-highest level of 2016.

At the same time, there’s plenty of money on the sidelines, and some of it appears to be returning to stock funds. In the last week of 2016, investors poured an estimated $118 million into U.S. stock funds. But that’s a piker compared to the previous week, when an estimated $18.6 billion flooded — more than the previous 24 months combined, according to the Investment Company Institute, the funds’ trade group.

As of the end of November, there was $2.7 trillion in money market mutual funds, earning approximately zilch. A roaring stock market provides a great deal of temptation for at least some of that money.  Stock funds had about 3.2% of their assets in cash, which is not particularly high, and that figure’s usefulness has been eclipsed somewhat recently.

Another potential source of cash: Companies in the S&P 500 have a record $1.5 trillion in cash cooling its heels on their balance sheets. They can use this for buying back stocks, paying dividends, or — and this is crazy talk — reinvesting in plants, equipment and their own employees.

The bad news is that the stock market is already expensive. The S&P 500 sells at about 24 times earnings, as opposed to a historical norm of about 17 times earnings. S&P predicts that earnings will rise through 2017, bringing down the PE ratio to about 18. Bear in mind that forecasts are notoriously unreliable, particularly when they’re about the future.

Bear in mind, too, that the Federal Reserve is likely to continue to raise interest rates, and at a faster pace if the economy grows faster than expected.

Right now, it looks like animal spirits and plenty of cash will keep the market party going, and that can be good, clean fun. Enjoy the ride. Just remember that market rallies always last longer than a sober person would think. But remember that many things must go right for the rally to continue. It’s probably a good time to readjust your portfolio back to your original goals. No one ever went broke taking a bit of profits.

 

 

 

 

Rockets’ red glare, redux

When you live near Washington, as I do, the military is never far from your mind. As I mentioned in this post, Fort Washington, which failed to defend the area in 1812, was not far from my home when I was growing up. You can’t drive down any street in Northern Virginia without running into a historical marker about the Civil War. The Pentagon, Arlington National Cemetery and the World War II Memorial are an easy drive from here.

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One of Fort Washington’s guns. 

Back in July 2015, I noted that defense stocks seemed like a decent investment idea, given the enormous amounts of money the nation spends on the military — currently $619 billion. I’m happy to report that the two aerospace & defense ETFs mentioned in the post,  iShares US Aerospace & Defense (ITA) and SPDR Aerospace & Defense (XAR), have risen at an annualized 13.94% and 11.14%, respectively, since I published the post. The Standard & Poor’s 500 stock index has risen at a 6.92% pace.

Before I do a victory lap in a shiny new F-35, however, I should note that timing is everything. Before the election, SPDR Aerospace & Defense (XAR) lagged the S&P 500, rising at a 2.11% pace, vs. 3.32% for the S&P.  iShares US Aerospace & Defense (ITA) faredm s0mewhat better, gaining 6.05%.

dscn2439
Hey kids! Let’s go to the Civil War reenactment! It will be fun!

The stocks have popped because of the incoming administration’s pledge to increase military spending. Betting on what any administration can and will accomplish is, of course, a risky bet. Congress isn’t in a particularly spend-y mood, even given the election results. And judging from Mr. Trump’s objections to the cost of a new Air Force One (actually two, and it’s only Air Force One when the president is in it), some penny-pinching may be in the future for defense as well as the rest of government.

At least a fairly major increase in military spending has already been built into defense stocks. The iShares offering now sells for 21.56 times its past 12 months’ earnings, while the SPDR fund sells for 22.37. (The latter fund tends to have more small-cap stocks). The S&P 500 is at 19.86 times earnings, which is well above its average of about 16.

Could they go higher? Sure. Americans don’t object to defense spending the way they do to social spending. And everyone seems to remember that the massive spending in World War II helped push the nation out of the Great Depression. (This was a massive government spending program that we still haven’t paid off, but never mind.)

 

dscn2331
The cemetery at Gettysburg. 

Bear in mind, however, that you need two conditions to make a profitable war. First, of course, you have to win it. (Ask Germany and Japan). Second, it’s best not to fight it on your own ground. (Ask France.)  The best use for a cannon is not to use it at all.

 

 

They don’t ring a bell

According to hoary Wall Street lore, they don’t ring a bell when a bull market ends or a bear market begins. (Those would actually be the same thing). But Federal Reserve Chair Janet Yellen did all but that today when she spoke at the Kansas City Fed’s economic conference in Jackson Hole, Wyoming.

“I believe the case for an increase in the federal funds rate has strengthened in recent months,” Yellen said, which is just about as close to skywriting “RATES ARE GOING UP!” as a Fed chair can get. Wall Street, which has anticipating higher rates since 2009, reacted predictably, selling off stocks and bonds at the same time. The Dow Jones industrial average fell 53.01 points, to 18,395.40, and the bellwether 10-year Treasury note yield rose to 1.635%. Bond prices fall when interest rates rise, and vice-versa.

Naturally, the case for raising interest rates soon is debatable. In terms of timing, the Fed is traditionally reluctant to raise rates in the months before a presidential election. If that reasoning still holds, the next opportunity to increase the key fed funds rate would be in December.

And on a relative basis, interest rates are pretty high already. The fed funds rate is 0.25% to 0.50%. The European Central Bank’s rate is zero, as is the Bank of Japan’s. The Swedish central bank’s rate is -0.25%, and the Swiss government rate is -0.75%.

The Fed doesn’t control long-term interest rates, but the picture there is just as grim. Germany’s 10-year yield is -0.07%. France’s decade note yields 0.17%, albeit with a certain je ne sais quois. Italy’s 10-year rate — Italy’s! — is 1.17%.

What is starting to make the Fed uneasy, however, is rising wages. The Fed has been able to flood the world with easy money for nearly a decade without fear of a wage-price spiral because wages have been flat for more than a decade. You just can’t have a wage-price spiral without higher wages.

Oddly — and somehow justifiably — those at the lowest end of the wage spectrum have been seeing the biggest wage increases, thanks in large part to state-mandated minimum-wage increases. But that’s not the only reason. Many companies, such as Walmart and McDonald’s, have come to the realization that they rely heavily on those who face the public. Those people are almost invariably on the lower end of the wage spectrum.

Perhaps Lily will get a raise.
Perhaps Lily will get a raise.

Service companies are also discovering, to no one’s surprise than theirs, that people who don’t make much don’t feel a lot of loyalty to their employers. Low-wage employees will often gladly jump ship to another company that pays better wages. In the recession, companies could simply say, “Be glad you have a job.” But many of the new job gains have gone to low-income employees — so much so, in fact, that there’s a relative shortage of people willing to take low-wage jobs.

“Wage acceleration has been concentrated in low-pay sectors, such as restaurants and retailing,” says Bank of America Merrill Lynch. “In our view, the increase in low-pay wages is due to state-level minimum wage increases and a shortage of younger, less-educated workers. We see sharp increases only in low wage sectors: broader wages should rise more gradually as joblessness falls.”

The Fed raises interest rates to slow the economy and reduce the threat of inflation. But bear in mind that interest-rate increases take a long time — 18 months or so — to fully take effect on the economy. Furthermore, a more or less normal fed funds rate, which is neither accommodative nor restrictive — is somewhere between 3% and 4%. It will take many more quarter-percent rate hikes to get back to normal.

The big danger is that the economy isn’t exactly boiling over. Current estimates for third-quarter gross domestic product are a 1% increase or less.

If you’re looking for a rate shock, you probably won’t see one any time soon. You may start to see better rates on bank CDs: The top ones now yield about 1%, according to Bankrate.com. But you should start to be wary of interest-rate sensitive stocks, such as utilities and preferred stocks. And if you’re thinking of loading up on bonds, you might want to wait a bit.