Back in the days when we communicated by graphite scrawls on dried wood pulp, I would occasionally get notes from relatives wishing me a speedy recovery from my broken arm. Subtlety was not my family’s strong point.
Communicating by pixels in phosphor, alas, hasn’t sped up my process much. To answer a few questions:
Q: Did you break your arm?
Q: Is that any way to keep a lawn?
A: Hey, I’ve been busy.
Q: Doing what?
A: Writing. Just not here. But you can read my latest column in Morningstar right here. More to come shortly.
And as the smart ship grew
In stature, grace, and hue,
In shadowy silent distance grew the Iceberg too.
— Thomas Hardy, The Convergence of the Twain (Lines on the loss of the Titanic)
Thomas Hardy’s poem makes sardonic note that, while the Titanic was taking form in the Bellfast shipyard, so, too, was the iceberg that doomed it. And, while each bull market grows, so do the forces that will eventually cause it to stop.
What will cause the death of this bull market? No one really knows, and the nature of a bear market is that few see it coming. But if I were to put money on it, the most likely assassin would be the Federal Reserve, rather than disappointing Facebook earnings.
The Fed’s job is to keep the economy on a sustainable growth rate, which means that the economy should grow fast enough to keep unemployment low without inflation. (To the cognici, this is the non-accelerating inflation rate of unemployment, or NAIRU, which sounds like something out of the Mork and Mindy Show.) Just what NAIRU is is a matter of debate among economists. It’s enough to know that the Fed tries to balance inflation, interest rates and employment.
When the economy is sluggish, the Fed lowers short-term interest rates, which makes it cheaper for companies to borrow and invest. It allows people to refinance mortgages and other debts at a lower rates – essentially, putting money into their pockets.
When the economy is growing too fast and inflation is rising, the Fed raises short-term interest rates to slow the economy. When rates rise, it’s more expensive to borrow, which slows the housing market and makes companies more wary of borrowing.
While the Fed may say that it doesn’t want to cause a recession or slow down the stock market, rising interest rates often do both. A recession wipes out wage inflation: You can’t have wage inflation if people are getting laid off, and you can’t have a wage-price spiral without rising wages. Most stock investors know that higher rates can augur recession, and they tend to sell stocks as rates creep higher. And, on a technical note, stock analysts tend to reduce price targets when interest rates rise.
The most famous example of the Fed crushing stocks and the economy was in 1981, when the Fed hiked short-term interest rates to the highest in modern history: The three-month Treasury bill yielded 16.3% in May of that year, and a sharp recession followed. Inflation, as measured by the Consumer Price Index, fell from 9.79% in May 1981 to 2.36% by July 1983.
But most other bear markets have been preceded by rising rates: The 1987 market crash, for example, as well as the 2000-2002 tech wreck and the 2007 financial meltdown. While none of those rate hikes were as severe as in 1981 – and you can debate whether they were the proximate cause of the bear market – few bear markets start after a prolonged period of the Fed cutting rates.
The Fed has raised its key fed funds rate seven times since 2015, admittedly from its lowest base ever. The central bank’s target is between 1.75% to 2.0%, and most predict it will raise rates at least one more time this year, and possible several more times next year. Already, the yield on most money market funds is higher than the dividend yield on the Standard & Poor’s 500 stock index.
What does all this mean? If you have ten or more years to reach your savings goals, not a thing. In fact, a bear market is a good thing if you’re young and contributing regularly to a stock fund in a retirement account. You get the chance to buy stocks cheap over a long period of time.
If you’re close to your goal, however, you should at least think about how much you have in stocks. The most logical way is to rebalance: If you set a goal of 60% stocks and 40% bonds, for example, you’re probably out of balance now. It wouldn’t hurt to sell enough stocks and buy enough bonds to get back to that 60% and 40% risk. Somewhere out in the future, rising stock prices and rising rates will converge, and the results are rarely pretty.
When it comes to investing, you’re better off with a pack of dogs, rather than just one pup. And the returns from Dogs of the Dow this year provesit.
The basic premise behind the Dogs of the Dow is fairly elegant. You’re supposed to buy stocks low and sell them high. But many stocks deserve to be low: They’re poorly managed, like Wells Fargo, or they’re in a dying business, like Gannett, or they’re really just walking catastrophes, like Enron.
Whatever the faults of the Dow, the 30 stocks in the Dow Jones industrial average are large-company high-quality stocks spread across a variety of industries. But each year, some of these companies lag the broad index and others lead. It’s just the nature of the market, which loves different industries at different points in the market.
The ones that are unloved — and, hence, dogs — are the ones with the highest dividend yields. Companies normally don’t have high yields because their executives are swell people who want to dole out profits to investors. Most often, it’s because the company’s stock price has been clobbered.
After all, a stock yield is a function of two factors: Its 12-month payout divided by its current price. A stock with a $1 annual dividend and a $50 price has a 2% yield. Drop the price to $40, and the yield pops up to 2.50%. So typically, a Dog of the Dow has a high yield because its stock price has been clobbered.
Last year’s dogs rose by an average 23.6%, vs. 21.83% for the Standard & Poor’s 500, proving that sometimes it does indeed pay to buy low and sell high. (The Dogs of the Dow have had a spotted record the past few years).
This year’s Dogs of the Dow prove a further point: It’s better to invest in 10 stocks than one or two. Here are how 2017’s dogs fared last year:
The North American Securities Administrators Association (NASAA) are on the front lines fighting investment fraud. When they start sounding alarms, it’s usually best to listen. And today they’re sounding the alarm on all things crypto.
Borg: “Go beyond the headlines and hype to understand cryptocurrency investment risk.”
WASHINGTON, DC (January 4, 2018) – As cryptocurrencies continue to garner national and international headlines, the North American Securities Administrators Association (NASAA) today reminded Main Street investors to be cautious about investments involving cryptocurrencies.
“Investors should go beyond the headlines and hype to understand the risks associated with investments in cryptocurrencies, as well as cryptocurrency futures contracts and other financial products where these virtual currencies are linked in some way to the underlying investment,” said Joseph P. Borg, NASAA President and Director of the Alabama Securities Commission.
Cryptocurrencies are a medium of exchange that are created and stored electronically in the blockchain, a distributed public database that keeps a permanent record of digital transactions. Current common cryptocurrencies include Bitcoin, Ethereum and Litecoin. Unlike traditional currency, these alternatives have no physical form and typically are not backed by tangible assets. They are not insured or controlled by a central bank or other governmental authority, cannot always be exchanged for other commodities, and are subject to little or no regulation.
A NASAA survey of state and provincial securities regulators shows 94 percent believe there is a “high risk of fraud” involving cryptocurrencies. Regulators also were unanimous in their view that more regulation is needed for cryptocurrency to provide greater investor protection.
“The recent wild price fluctuations and speculation in cryptocurrency-related investments can easily tempt unsuspecting investors to rush into an investment they may not fully understand,” Borg said. “Cryptocurrencies and investments tied to them are high-risk products with an unproven track record and high price volatility. Combined with a high risk of fraud, investing in cryptocurrencies is not for the faint of heart.”
Last month, NASAA identified Initial Coin Offerings (ICOs) and cryptocurrency-related investment products as emerging investor threats for 2018. Unlike an Initial Public Offering (IPO) when a company sells stocks in order to raise capital, an ICO sells “tokens” in order to fund a project, usually related to the blockchain. The token likely has no value at the time of purchase. Some tokens constitute, or may be exchangeable for a new cryptocurrency to be launched by the project, while others entitle investors to a discount, or early rights to a product or service proposed to be offered by the project.
NASAA has developed a short animated video to help investors understand the risks associated with ICOs and cryptocurrencies. NASAA first alerted investors of the risks associated with cryptocurrencies in 2014.
Common Cryptocurrency Concerns
Some common concerns investors should consider before investing in any offering containing cryptocurrency include:
Cryptocurrency is subject to minimal regulatory oversight, susceptible to cybersecurity breaches or hacks, and there may be no recourse should the cryptocurrency disappear.
Cryptocurrency accounts are not insured by the Federal Deposit Insurance Corporation (FDIC), which insures bank deposits up to $250,000.
The high volatility of cryptocurrency investments makes them unsuitable for most investors, especially those investing for long-term goals or retirement.
Investors in cryptocurrency are highly reliant upon unregulated companies, including some that may lack appropriate internal controls and may be more susceptible to fraud and theft than regulated financial institutions.
Investors will have to rely upon the strength of their own computer security systems, as well as security systems provided by third parties, to protect purchased cryptocurrencies from theft.
Common Red Flags of Fraud
NASAA also reminds investors to keep watch for these common red flags of investment fraud:
“Guaranteed” high investment returns. There is no such thing as guaranteed investment returns, and there is no guarantee that the cryptocurrency will increase in value. Be wary of anyone who promises a high rate of return with little or no risk.
Unsolicited offers. An unsolicited sales pitch may be part of a fraudulent investment scheme. Cryptocurrency investment opportunities are promoted aggressively through social media. Be very wary of an unsolicited communication—meaning you didn’t ask for it and don’t know the sender—about an investment opportunity.
Sounds too good to be true. If the project sounds too good to be true, it probably is. Watch out for exaggerated claims about the project’s future success.
Pressure to buy immediately. Take time to research an investment opportunity before handing over your money. Watch out for pressure to act fast or “get in on the ground floor” of a new tech trend.
Unlicensed sellers. Many fraudulent investment schemes involve unlicensed individuals or unregistered firms. Check license and registration status with your state or provincial securities regulator. Contact information is available here.
International markets seem to have awakened after a long, long nap. These funds have excellent returns and positive alpha — which means they have done better than might be expected, given the risk they take.
Bear in mind that you’re taking on stock-market risk as well as currency risk, which is one reason why I don’t generally advocate huge international positions. But if you’re in the market, this is a decent place to shop. And, yes, there’s a paywall here, but it’s for a good cause.
“By the sweat of your brow you will eat your food until you return to the ground, since from it you were taken.”
One of the enduring mysteries of the U.S. tax code is why the system is harder on those who earn their income by the sweat of their brow as opposed to those who get money from their investments.
The tax code’s main purpose, of course, is to fund the activities of the government, and Americans have been having a lively discussion about the proper scope of government activities and how to pay for them for more than 200 years.
Over the years, however, the tax code has been used to encourage certain behaviors and discourage others. In its current incarnation, for example, we give deductions for contributions to some retirement savings accounts, because that’s a good thing. We levy tax penalties on early withdrawals from retirement plans, because that’s often a bad thing.
There are plenty of things to argue about with these types of tax incentives. What is curious, however, is the favorable treatment of investment returns over ordinary income. Currently, for example, employment income is taxed at a maximum 39.6%, while long-term capital gains are taxed at a maximum 20%.
Ostensibly, the lower tax rate for capital gains – the difference between your purchase price and sales price on a winning investment – is to encourage investment. As such, it has some merit: Congress cut the capital gains rate from 28% to 20% in 1982, and the stock market took off. (On the other hand, Congress returned the capital gains rate to 28% in 1987, and the stock market generally rallied until 2000).
Nevertheless, we as a nation tend to encourage hard work and look down on those who work as little as possible. And here we come to a paradox between the admiration for hard work and the tax code. Consider this comparison of two people, each with $300,000 in income, presented by Ben Steverman of Bloomberg.
Our first taxpayer is an emergency room surgeon. The other plays video games all day, thanks to his inheritance.
Now, as with all things taxable, there are some important caveats here. One is that under current law, if the heir’s parents gave him his capital in their will, the estate is liable for taxes under estate tax law. (Heirs don’t pay estate taxes.) That said, it’s unlikely that the parents paid estate tax: It doesn’t kick in until $11.2 million for a couple and $5.6 million for a single individual. About 11,300 estate tax returns were filed for people who died in 2013, of which only 4,700 were taxable, fewer than 1 in 550 of the 2.6 million people who died in that year, according to the Tax Policy Center.
This is largely an investment blog, so it’s useful to point out that lower corporate taxes in the new tax bill means that companies are more likely to increase dividends, buy back stock, or increase merger and acquisitions. All told, it’s hard not for investors to like the bill, because it will help returns from the money you earn while you sleep. But we’re a country that admires hard work. In the end, however, even with a tax break, those who earn their living by the sweat of their brow still wind up paying more.