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.

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.

 

 

 

 

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.

 

 

 

 

Greetings from Lacunaville

SDSC_0368tarting in January, I’ve been writing full-time for InvestmentNews, doing a monthly column for Money magazine, and studying for the Certified Financial Planner mark. (This, apparently, is also a test of your prowess with a hand-held calculator). And I went to Africa.

The blog, as you may have noticed, has, um, languished. I’m hoping to revive it on a somewhat irregular basis, which, come to think of it, is pretty much its usual schedule.

I’ll be updating my links pages in the next week or so. In the meantime, here are some things to watch for today, as well as some things I’ve found interesting or peculiar.

This week, all eyes are on the Bureau of Labor Statistics’ employment situation report, out at 8:30 a.m. Friday. But the stock market seems to be resigning itself to an interest rate hike, probably in June or July. (A later hike would give the impression of a political motivation, and the Fed generally doesn’t like to do that). The current consensus estimate for new nonfarm jobs is 158,000, according to Bloomberg, with the unemployment rate falling to 5%. (And, yes, the total unemployment rate is still high, but it’s the nonfarm payrolls number that Wall Street watches.)

Wages also seem to be firming up, and it should be interesting to see if traditional summer employers, such as ice cream vendors and lawn mowers, have a hard time finding help this year. All of these would seem to give the green light to the Fed to raise rates.

Of course, we’d be talking about a lordly fed funds rate of 0.5% to 0.75% after a Fed hike, an increase that will be promptly reflected in your credit card bill and eventually in your money market mutual fund account. For those who still watch their money fund account, the average money fund now yields 0.10%, nearly triple its rate at the start of the year.

DSC_0353The stock market typically dislikes interest-rate hikes. Higher rates mean bonds become more competitive with stocks, and increase short-term borrowing rates. On the other hand, higher short-term rates mean that companies will earn somewhat more on their cash, and that savers will earn slightly more on their cash.

The old adage about Fed rate hikes — three steps and a stumble — meant that the stock market takes the first two hikes as a sign that the economy is improving, and rallies. At the third hike, stock investors realize the Fed wants the economy to slow, and stocks sell off. Bear in mind that the adage originated when a normal fed funds rate was 4% to 5%. It would take a stairway, not a few steps, to get us back to the traditional stumble level, assuming the Fed raises rates at a quarter-point a pop.

I’m an optimist, and think that rising earnings are a good thing — in fact, the one thing that the economy desperately needs for sustained growth. Most companies, despite their complaining, have nice profit margins, good balance sheets, and plenty of cash. They might even be surprised to learn that when their employees get raises, they spend more — and even on the products their employers sell.

DSC_0488The one caveat: Stocks aren’t cheap, at least by the price-to-earnings ratio of the Standard and Poor’s 500 stock index. The current PE, based on forward earnings estimates, is 17 — a tad feverish, although nothing like the levels during the technology bubble. Nevertheless, at these levels, it’s a bit like driving a bit too fast on old tires. If the market takes a rate hike really badly, investors could find that both bond and stocks slide off the road. And in that case, having a bit of cash in a money fund might be a good safeguard.

 

The week ahead

Only two things matter in this first week of the new year: China and jobs. And China, frankly, isn’t looking too good.

The market plunged at the open Monday on news that Chinese manufacturing was far worse than Wall Street expected. The Chinese purchasing managers’ index fell to 48.2 last month, vs. 48.6 in November, it’s 10th consecutive decline. When the index is below 50, the manufacturing sector is in recession.

The Chinese stock market took one look at the numbers and promptly plunged 7% before circuit breakers kicked in. Wall Street took a sober look at the Chinese market’s reaction and promptly panicked. The Dow Jones industrial average is down 318 points, or about 1.8%, as I write this.

China takes these things seriously: So seriously that Chinese CEOs are starting to mysteriously disappear. If I were a Chinese CEO today, I’d be hastily packing my bags.

The stalling Chinese economy will weigh heavily on the U.S. market, since so many U.S. companies have been counting on China for increased sales and growth. So today, the stock market will be digesting this news, and discounting stocks across the board.

fredgraphAfter that, Wall Street will spend the rest of the week fretting about jobs. And there are all sorts of indicators to watch in the run up to Friday’s jobs report. (Which, for the record, is expected to show 200,000 new jobs in December, vs. 211,000 in November.)

  • Tuesday is motor vehicle sales, which should show fairly robust growth in what was once the nation’s largest employers. Analysts are expecting fairly robust gains in December, thanks to low gas prices and the prospects of modest raises in 2016. Another factor: The average U.S. auto is more than 11 years old. Cars age better than they used to, but there’s a lot of pent-up demand for new cars.
  • Wednesday is the ADP Employment report, which is a pretty good predictor of how the Friday jobs report will turn out. The consensus on the report, which excludes government jobs, is for 190,000 new jobs in December.
  • Thursday is the volatile weekly unemployment claims report, has ticked up to the highest levels since July, when the numbers flirted with lows unseen since the Nixon administration. Another important report is the Challenger Job Cut Report, which measures mass layoffs. Many companies choose to lay off employees just in time for the holiday season, so it should be an interesting report.

 

How the naive are faring

You could line up all the advisers from here to Albuquerque, and you still wouldn’t reach a conclusion as to the best diversified portfolio for your retirement savings.

Because of that, many investors simply use the 1/n portfolio — which is to say, they divide their money equally among all the options in their 401(k) plan. Among those who study these things, this is called the Naive Portfolio.

What would a Naive Portfolio look like? Most 401(k) plans are not exactly paragons of fund-picking: They often choose the largest funds. After all, those funds typically have decent long-term records and low expense ratios, and no one is going to get sued using those criteria.

Let’s compose a naive portfolio of the 10 largest mutual funds. It would look like this, ranked by size:

Tot. ret. Tot. ret.
Fund Ticker Category 2015 5 years
Vanguard Total Stock VTSMX Large blend 2.37% 13.98%
Vanguard 500 Index VFINX Large blend 2.89% 14.23%
Vanguard Total Intl Stock Idx VGTSX For. large blend -2.35% 3.30%
Vanguard Total Bond VBMFX Interm. bond 0.68% 2.86%
Growth Fund of Amer A AGTHX Large growth 6.98% 13.78%
Europacific Growth A AEPGX For. large growth 1.57% 5.49%
Vanguard Prime MM VMMXX Money market 0.03% 0.03%
Fidelity Cash Reserves FDRXX Money market 0.01% 0.01%
JPMorgan Prime MM VPMXX Money market 0.01% 0.01%
Fidelity Contrafund FCNTX Large growth 7.93% 13.87%
Average 2.01% 6.76%

Source: Morningstar.

So how did our naive investors do? At least this year, they have done pretty darn well. The average expense ratio in this portfolio is 0.35%, which, honestly, you can’t beat with a stick.

Furthermore, a 2% return is just a shade lower than what you would have gotten with a single investment in the Vanguard Total Stock Index fund. And you would have gotten that return with far less risk than a pure stock index fund, given that 30% was in money market funds and 10% in bonds.

 

Just how successful a naive investment would be over the long term is a more difficult calculation, which I’ll tackle in future posts. But the takeaway is that naive diversification is probably better than no diversification at all.