How To Invest With Coming Debt Crisis – Don’t Be The Turkey

Three extremely important pieces of information released over the last weeks for investors are:

  • The increase in US budged spending and consequently deficits.
  • The ECB’s public stance that they are going to print money, buy assets and do whatever it takes to prevent a recession.
  • The FED is ready to lower rates to keep economic growth stable.

My main concern is that we are in a Thanksgiving turkey situation and have a real turkey problem. What is the turkey problem?

The turkey is born, and fed more and more each day. The turkey thinks everything is perfect, food is coming in larger and larger quantities and there is absolutely no risk. As the days go by, the turkey’s wellbeing constantly increases. You can read more about Black Swans and turkeys in my Nassim Taleb articles.

1 turkey problem

Similarly, governments think they can spend money and not care about deficits. The central bank heads will do whatever it takes to keep things going well by printing more money and we, governments, corporations etc. all feel like turkeys. Think about it, aren’t you feeling good like a well-fed turkey and your wellbeing is constantly increasing?

There is only one minor issue, at some point in time, the butcher feeding the turkey, decides to prepare it for Thanksgiving. Similarly, the money printing game will end, it has happened a thousand times in history and currencies always debase, i.e. lose their value.

2 turkey problem

The key here for investors is not to be the turkey. Let’s start by explaining the economic fundamentals, the financial engineering provided by central banks and then conclude with how to invest so that your portfolio doesn’t end up like a Thanksgiving turkey.

Content:

Economy and monetary policy:

  • US budged deficits
  • Lower interest rates, money printing

How to invest:

  • Be like a government – have debt, but smart, good debt
  • S&P 500 to 5,000 points in 2030 but index fund investors will not be happy
  • Buy value like Buffett did in the last 50 years

US Budged Deficits

For me, one of the most important pieces of information over the last weeks was the ballooning of the US budged deficit.

3 us budged deficit

Source: Bloomberg

If we look at what the Congressional Budget Office has to say, The Budget and Economic Outlook publication shows how the US budged deficit will be larger than $1 trillion per year very soon.

4 budged defitic

Source: CBO

This means that the US total public debt will continue to grow at extremely fast rates.

5 total public debt

Source: FRED

The public debt is now 22 times higher than what it was in 1981. From my point of view, spending more than what you make can only last for a while, but sooner or later the butcher will come. Now, I know interest rates are lower and the debt cost servicing isn’t high, but interest rates can change if central banks lose control and history teaches us; sooner or later, central banks always lose control.

  • Lower rates, monetary easing and stimulus

Given what is going on with governments debt levels, corporate debt levels and even household debt levels, central banks have no other option to keep interest rates low, practically at zero, and promise to print as much money as necessary when necessary.

So, we have the FED saying how it will cut rates to sustain economic growth.

6 fed rate cuts

Source: WSJ

And we have Mario Draghi practically saying how the ECB will do whatever it takes to stimulate the economy.

7 draghi

Source: Bloomberg

My conclusion is that over the longer term, money will be printed and currencies debased or better to say sacrificed. Economies and businesses will be stimulated but sooner or later this too will pass. We have to be very careful, not to be the turkey.

How to invest to not end up like a turkey before Thanksgiving

If everybody has a lot of debt, especially governments, it means all policies will help the majority, i.e. those with debt. So, let’s say you have a 30-year mortgage with a fixed interest rate of 3.5% like I have and let’s say currencies lose 50% of their value over the next decade due to inflation. This would mean that the value of your house would go up 50%, your salary too, while your mortgage payment would remain the same.

8 inflation

You are practically playing the same game as governments.

Secondly, the ECB and the FED say they will buy assets, which means the value of financial assets will continue to go up as it did in the last ten years. I would not be surprised to see the S&P 500 at 5,000 points with index fund investors not happy about it.

If we see inflation, which is very likely to escalate somewhere in the future because it is never linear and the FED and ECB will lose control, especially the ECB that doesn’t have any kind of coherence within. Everybody is happy to get free money from money printing, but when things get ugly, we will see for how long will Europe last.

In 1961 it looked like there will be no inflation to worry about given that inflation was at 1.2%. However, over the following two decades, inflation was often above 5% and peaked at 13.5% in 1980.

9 inflation us

Source: FRED

My point is that by focusing on value investing, like Warren Buffett did over the last 50 years that have had significant inflation, you can do better than what the S&P 500 offers even if it doubles in the next decade.

The S&P 500 did go up 28 times since 1981, but Berkshire did just a bit better.

12 berkshire

The difference comes from the focus on businesses, that have moats, have pricing power and can consequently adapt to inflation. Therefore, when investing, and you have to be invested because currencies will be worthless, focus on buying value, businesses that will do good no matter what. Thus focus on risk and reward, exactly what value investing is.

Receive a weekly overview of published articles, videos and research reports straight to your inbox for boring long-term investing knowledge!

Stock market news – the FED, interest rates and global economic slowdown

Today we are going to talk about the economy and how it affects us investors and what to expect in the next 20 years! The news of the week was that the FED that will keep interest rates low:

1 FOMC

And the second very important news is that the global economy is slowing down and the growth is lowest since the financial crisis!

global economy, what will you focus on

Source: Bloomberg

How does that affect our investing? Is it important at all?

Let’s start with the FED, some think the current interest rate is close to the neutral rate and that should be it.

2 neutral rate

Source: Oxford Economic

Plus, that last interest rate hikes, have slowed down economic growth in the United states but have brought it to what is expected to be normal long term.

3 us growth

Source: Trading Economics

What does it all mean for investors?

Well, the FED will protect you as much as it can and as in Europe, they will do whatever it takes to keep the situation calm. As long as we don’t have inflation things will be good. Plus, it is hard to have inflation when there is so much supply of everything due to the same low interest rates.

However, lower interest rates just postpone the inevitable, which is that the economy is always cyclical and after all it all boils down to productivity. Policy can influence growth in the short term, prevent crises, which also means you can’t time a crisis. Nobody knows what kind of recession will come next and when it will strike.

Postponing means that you might make 20% per year for 5 years and then lose just 20% in one year when there is a recession. The point is that even if it all looks terrible in the form of high debt, low interest rates, it might go on for a decade, or inflation might change things. Therefore, try to find both good investments and protection in case of inflation. The best investments will always be quality.

Global economic situation

On a possible global recession, and something to keep in mind also when watching the specific country growth rates, on one side we will have the slowest global growth since the financial crisis but on the other hand, global growth has been 3% compounded over the last 10 years.

The average since 2000 is probably 4%. This means that over the last 20 years, despite the global financial crisis in 2009, the global economy more than doubled. It will probably double again in the next 20 years and there will probably be one or two recessions. Keep that in mind when investing.

What did stocks do over the last 20 years? Stock doubled!

4 doubled

Source: Macrotrends

Given that the current PE ratio, in the lowest tax environment I expect we are going to see going forward.

6 corporate tax

Source: Wiki

But even if taxes go up, the difference in return will be 1% or something per year, not significant and something not to worry even if the media has already started talking about it.

5 pe ratio

Source: Multpl

I would say, passive investors should expect their money to double over the next 20 years, perhaps a bit more than that with significant ups and downs during the period.

How to invest for the long term?

If you want higher returns, from these levels I think one can easily beat the S&P 500 and other indexes because it was a hard thing to do from 1982 when the PE ratio was 7, thus the return 15%. Now that the return is around 5%, by looking at businesses that offer more, you can do that over the next 20 years. What is the difference?

$100 * 1.05^20 = $265

$100 * 1.1^20 = $672

$100 * 1.15^20 = $1636

My mission is to help those who want more than 5% per year.

The message is simple and I will never get tired of repeating it because it is so important:

Invest in value that will give you a good return over the long time, that will benefit from the fact that the global economy will probably double over the next 20 years and that gives you a margin of safety.

You might buy an airport, fertilizer stocks that we will discuss on Sunday or who knows what. But keep those things in mind. The global economy will double in the next 20 years, no matter the news. Some businesses with quadruple, some will go bust, looking long term, you have a chance to find those that will quadruple.

Long term investing is the most important advantage we have. It allows us to take advantage of the irrationalities that emerge from Wall Street’s and everyone’s focus on the short term.

Receive a weekly overview of published articles, videos and research reports straight to your inbox for boring long-term investing knowledge!

To Buy or to Sell Stocks with Crash Coming? Doesn’t Matter for Value Investors – Buy Value

I received this very interesting comment from a subscriber as I bought my 5th stock for my lump sum portfolio which is now 50% invested. So, I invested 50% of my portfolio over the last 3 months that might surprise people scared of the upcoming crash or recession.

stock market crash

I have 3 points to answer this question:

  • I can’t predict the future, nobody can

Nobody knows what will happen with the market, we have the last two crashes in our mind that were close to 50%, but that doesn’t mean it will happen again. Nobody, and I mean nobody knows.

  • A recession is always around the corner

There are recession predictions for 2019 and 2020, but the same could had been said in 2018, 2017, 2016, 2015, 2014, 2013, 2012, 2011, and especially 2010 and 2009. There are many out there that have been waiting on the side-lines since 2009 or they just got in in the last few years. No need to mention the missed opportunities.

For example, my largest position in January 2018 was Nevsun Resources.

3 nevsun

In January 2018 there were fears about China slowing down leading to a copper crisis etc., fears of a recession and market crash over the next two years with Ray Dalio saying there is a 70% chance for an U.S. recession. I would have been better in cash than investing in a copper miner, right?

Well, all depends on value, if you find it, even if a recession happens, your returns are delayed by a year to 3. The point is that if you buy value, you will survive those bad years and get ahead after the crash. So, I, as a selective investor, simply buy when I see value and when I am happy owning the business. It has rewarded me very well in the past no matter the possible crashes. And yes, I lost money in 2008, but it is not comparable to what I made from 2009 onward and from 2002 to 2008.

Index fund investors

For those who invest in index funds, just invest on a monthly basis, just dollar cost average and forget about stocks, don’t even think about it, you will get your returns whatever they will be, own your home, invest in another property, diversify and you will be well off. Your wealth doesn’t depend on the market, but mostly on you and you not doing stupid things like most did, I.e. selling in 2009 march.

3) Highest possible return long-term

I know if there is a recession my portfolio will get hit, but I also know that the highest possible return I will get is when I buy value when I see it. So, in good years I will have great returns, in a bad year, I don’t know how I will do. There is a nice passage in the book Margin of safety by Seth Klarman discussing how when you buy value, real value, it often offers downside protection as it is already depressed in price and the price can’t go much lower. All my current 5 stocks trade below book value, mostly tangible book value, have high earnings yield and potential. So whatever happens, I am a happy owner, owning assets and that gives me a margin of safety.

To explain in an easy way what margin of safety investing is, I’ll make the next video article apple.

Receive a weekly overview of published articles, videos and research reports straight to your inbox for boring long-term investing knowledge!

Stock Market Crash, Economic Collapse, Rigged Markets? How to invest rationally!

Good day fellow investors,

Last week I made the news on the topic how one should focus on the businesses he invests in and not so much on the macroeconomics.

I’ve got this interesting email discussing how I am missing many points:

Underlying factors that affect the metrics you used in your article:

  1. The role of the ESF in market ‘rigging’. – U.S. Treasury’s Exchange Stabilization Fund
  2. Stock buybacks from the new tax code (fudging the numbers you are working with).
  3. The key role the central banks are playing by keeping interest rates artificially depressed, thus not exposing the true cost of debt servicing.
  4. The sheer number of Zombie companies and historic high levels of BBB bonds.

Plus, how I should contact Peter Schiff, Gregory Mannerino and I would get quickly to 100k subscribers!

All the above is all correct, if I make a business analysis, I get 2k views, if I put stock market crash in the title, I get 4 times more views.

1 views

And in this article, I really want to put the topics of market rigging, buybacks, low interest rates, zombie companies into an investing perspective because I think there is a big difference between investing and protecting yourself from something that might happen but doesn’t have to happen.

2 keynes

When it comes to investing, the key is to achieve the best risk reward return and always remain solvent, no matter how irrational the market might seem.

Contents

Stock Market Fear and Irrationality

THE MAIN QUESTION IS HOW TO INVEST?

Market rigging!

Stock buybacks from the new tax code (fudging the numbers you are working with)

Artificially depressed interest rates

Corporate credit, zombie companies, government debt

How to invest keeping the risks in mind

THE MAIN QUESTION IS HOW TO INVEST?

One should think about HOW TO GET BOTH; good returns from businesses and protection from what might happen while taking advantage of possible market rigging. That is what I focus on and the message of this article is to try to give more balance to the possibly predominant message on YouTube regarding Stock market Crashes and Economic collapses etc.

We as investors have to focus on how to get the best risk reward return to reach our financial goals. Let’s say that gold explodes in 2034, I bet you that 98% of all those invested in gold at the moment, would not have the patience to wait till then to realize profits. That is one, plus, by 2034, if you have $1k now and you get a 15% return because you understand the market;

You know it is rigged,

You know buybacks are strong,

You know interest rates will remain low, or inflationary due to the huge debt,

You stay away from zombie companies, buy those that will do even better when the competition dissolves!

Your 1k become 8k thanks to the power of compounding, earnings and dividends that you don’t get if you buy insurance. Actually, insurance is a cost.

Let me put the things into perspective!

Market rigging!

The market has been rigged since ever – it is in the interest of most politicians, policy makers and people that stocks go up, pensions go up, everybody has more money, more confidence, spends more and even wages go up a bit – so it is in the interest of the current economies that markets go up, collaterals go down, and everybody is pushing for it to go up.

Take advantage of it.

On silver markets, gold markets, there are many speculators that make it look crazy and rigged because there is no rationality there. You can’t eat gold; no dividend and it doesn’t grow. In the 1980-s the Hunt brothers tried to rig the silver market. They owned 30% of global silver but regulations broke them.

Silver price:

silver price

Stock buybacks from the new tax code (fudging the numbers you are working with)

4 smart

Source: Reuters

$940 billion of buybacks expected in 2019, that is 3% of the market.

There will be ups and downs, but some buybacks are smart if made below book value, or replacement value or intrinsic value, and those values are in the eye of the beholder.

5 bubyacks

Source: Yardeni

Try to find buybacks that increase your value, your ownership and avoid those that destroy shareholder value. Compare many stocks and you will find the difference.

Artificially depressed interest rates

As long as it works, it does good in the short term while it is uncertain for the long term – again, as an investor you have to understand the game and play it wisely. The tide could change with a big inflation, but that is why I invest in businesses that would do well if there is inflation but that also do well in this environment. I get dividends, I get growth, expansion etc.

6 rate

Source: FRED

Corporate credit, zombie companies, government debt

Governments and corporations have increased their leverage as low interest rates allowed for lower borrowing costs. US government debt quadrupled in the last 20 years.

government debt

Source: FRED

However, this situation can be solved with inflation for the government and with bailouts for corporations. Plus, when zombie corporations finally fail, the environment will be healhier for good businesses. I’ll talk more about that in the next article discussing Archer Daniel Midlands (NYSE: ADM) where the CEO actually hopes for higher rates to limit the competition.

How to invest keeping the risks in mind

Now, what I just said, doesn’t mean I completely disregard it, I’m not stupid, I am not invested in companies that would go bankrupt in case interest rates go up, I am looking for both, both good businesses, that offer business returns and protection in case of any kind of crisis.

You have three options to invest your money!

The first option is to focus on protection: gold, put options, Treasuries (if you can call them protection). The second option is to focus on businesses, growth, business returns and investments.

Your $1k becomes $8k in 15 years with a 15% yearly return. If you own gold, and the dollar loses 50% of its value, you are at $2k, no dividends, no business, a lot of stress because you depend on what others are willing to pay, not on actual value.

I must say I did a lot of research on macro, especially when I was writing articles on a daily basis three years ago as that was my job, but my conclusion is, that one should be smart and take advantage of what is going on and not bet on something happening because it is logical to happen.

The situation was crazy in 2009, and many sold what they had fearing the macro voices, I was buying businesses in 2009, nice 5 baggers for me.

2 gdx

I took a loan 4 years ago, bought a house, and it was probably the best risk reward investment in my life. Fearing a crash would have me being without huge gains over the last 10 years.

The third investing option is to have it both. For example, a company I was heavily invested in 2018 was Nevsun Resources, a copper miner with a promising project in Serbia. However, what the market disregarded was that 30% of revenue from the project were from gold, not just copper. So, you can buy investments that give you a business return but also protection just in case some of the above mentioned risks materialize. I am now exposed to silver with my portfolio, but if you would take a look at my portfolio, you would never imagine it has a silver call option in it. That is because I like it both; give me business growth and give me the insurance part for free.

Think about it, although so rational, I reiterate my question, is it and will it actually be profitable to be scared or you should simply see how to get the best out of it all?

To put things into perspective, don’t focus on what should rationally happen due to text books or chicken littles, but put probabilities onto every conclusion. What will happen in the future is probably something unknown, be ready for it by investing in both.

Receive a weekly overview of published articles, videos and research reports straight to your inbox for boring long-term investing knowledge!

 

Stock Market News – Forget About News

Stock Market News – Stocks might crash, recession ahead, so what?

Will there be a stock market crash, will there be a recession? In this article I’ll show you why it doesn’t really matter and what are the real things you should focus on!

We will discuss:

Contents

Politics and economic news vs. business news

Earnings are the key, not economics

Market valuations

Will there be a crash?

Earnings and volatility

How to take advantage of volatility

Invest when you are happy with the business earnings

 

Politics and economic news vs. business news

Over the past years, I’ve been making some macroeconomic videos, I like the mental exercise, analysing the long-term risks etc. However, I must say, all that ‘mumbo jumbo’; GDP, economy, debt, trade wars, employment, housing etc. hasn’t helped me at all when it comes to investing. I am subscribed to an economic newsletter from the Wall Street Journal and in the last 4 weeks there were two positive and two negative headlines all about the US housing market, so funny.

The fact is that companies are living beings that adapt to circumstances, grow and change over time. By looking at the business, not the economy is actually where I get my investing value. As I am really pushing on the research, more and more of it will be business specific and less macro. Although macro is fun to look at, discuss and you can talk about it for eternity, talking about it doesn’t really help your portfolio.

For example, the S&P 500 has been flat since January 2018.

news

Source: CNN Money S&P 500

The point is that nobody could have predicted where the S&P 500 could have gone, it could have been up 20% or down 30%. It is all a guess, no matter how much macro you study. The point is that we have to focus on the business, nothing else.

I’ll take this opportunity to discuss the real news and news that could be important for your portfolio.

  • Extremely important news 1: your long-term investment returns are driven by earnings

Earnings are the key, not economics

In 1999, S&P 500 earnings were 58.55 points. Today we are at 130 points. That is an increase of 122%.

2 S&P 500 earnings

Source: Multpl

How did the market do? Well, the S&P 500 was at 1282 points in 1999 and now it is at 2757 points, up 115%.

3 s&P 500

Earnings are up 122% and the market is up 115% over the last 20 years. In the mean time we have had the dot-com bubble crash, the great recession, a European crisis, Japan not growing anymore, a commodity boom and bust etc. Who knows what will we have in the next 20 years, but no matter what happens, good businesses will do well. Another thing that helps very much with determining stock market returns are valuations.

  • Keep an eye on valuations because the market is extremely differentiated

Market valuations

In 1999 the S&P 500 was at 1282 points with earnings of 58.55 that leads to a PE ratio of 22. Thus, the earnings yield is approximately 4.5%.

1282*1.045^20= 3091 points

According to the valuation, investors could have expected a return of 4.5% based on the valuation they were paying in 1999. The return was even a bit higher when you add the dividends of just below 2% per year.

4 s&P 500 dividend yield

Source: Multpl

The current market’s valuation is 21, so your expected long term investing yield should be around 4.5% as it was in the last 20 years.

5 S&P 500 pe ratio

Source: Multpl

Will there be a crash?

There will definitely be market crashes in the future but you can’t time them. Let’s say there is a crash of 30% 6 years from now but in the meantime, the S&P 500 grows at 5% per year. This would say that from the current 2757, the S&P 500 would go to 3694 points. If then it crashes 30%, we would be down to 2585 but by waiting for the crash you would have missed on the dividends so you wouldn’t be ahead. However, as we spoke that earnings are key, you can invest for higher than 4.5% returns by investing in earnings and taking advantage of the volatility.

  • The market is extremely differentiated and volatile – learn about the business

Earnings and volatility

If I look at the top 10 positions of the S&P 500, the PE ratios vary extremely and I can tell you that returns will vary extremely over the next 20 years.

6 pe ratio

Source: IVV

If we take a look at the top 10 S&P 500 holdings from 20 years ago, only two companies were there that are still in it.

7 top 10 1999

Source: ETFDB

Therefore, it is extremely important to look at try to understand where could your investment be in the next 20 years. This doesn’t mean that if a company falls out the top 10 it will be a bad investment. However, you can avoid buying companies with too stretched price to sales ratios and extremely high earnings valuations where the actual business doesn’t justify.

The point is that when you follow a company for a few years you begin to understand it much better than the media does, you understand its natural cycles and how to invest around those.

This allows you to take advantage of volatility. It is pretty simple if you have a long term view.

How to take advantage of volatility

The easiest was to take advantage of volatility is to rebalance your positions in relation to the earnings yield those offer.

8 rebalancing

The only problem is that you have to move your focus away from the news and future expected earnings and simply focus on the real current business earnings. Just 6 months ago, Apple’s stock was above $232 only to fall down to $142 in January and now rebound to $173. Apple’s earnings didn’t change that much, so if you focus on the earnings yield you can buy more when the earnings yield is higher, PE lower, and less when the yield is lower, thus the PE ratio higher.

I didn’t buy Apple, but in the summer of 2018 I invested a bit in Brazil because I did find an interesting business there.

9 brazil

Source: EWZ

I didn’t sell yet, but the increase in price gives me a nice thing to think about and see how it fits my portfolio. The point is that it is all easy when you invest in businesses. Which leads me to the most important news of all:

  • Invest in the business, be an owner

Invest when you are happy with the business earnings

By focusing on the earnings and not on the news, investing becomes easy. What is your required investment return?

4.5% – buy the S&P 500 and forget about it

7% – buy good businesses when their PE ratios are around 14

10% – same but at PE ratio of 10, or higher ratios buy with some growth

15% – look at good businesses in distressed sectors, value investments and take advantage of the market’s short term focus. This implies a lot of work but it is possible to find such opportunities.

To summarize:

  • Forget about news, focus on the business reality, the long-term reality
  • Earnings are the drivers of your investment returns, be a business owner
  • Focusing on earnings will allow you to take advantage of the market’s irrationality, or better to say volatility

News, economy, stock market crash, recession, GDP, Trump – not adding value to your investing, so focus on the business and that is what we do here, so please SUBSCRIBE!

Receive a weekly overview of published articles, videos and research reports straight to your inbox for boring long-term investing knowledge!

 

Prepare For A Currency Collapse

Good day fellow investors,

in the news last Friday, we discussed the earnings of various companies and how a long-term investor should approach those, check the video out if you haven’t. As promised, today we will discuss the economic environment, the FED’s shift in gears and how one should think about long-term investing in relation to what might happen.

I’ll explain how:

  • we are most probably going for a global currency collapse, that will happen sooner or later,
  • the economy doesn’t have to collapse, and
  • how stocks might better than other things.

Just before we start, I wish to thank you all for the great reviews on Amazon, we are in the company of greatness on the Amazon best seller list, with Nobel prize winners like Shiller, legendary investors like Lynch and great trading books like Market Wizards. I thank you all for your support.

18 books

The FED’s pause

Let’s start with the news, the last two weeks were filled with crucial news that is important to systematize and put it into context.

The key piece of information is the FED’s pause and change in rhetoric.

We can say the FED capitulated! The committee will be patient with rate hikes and adjust for whatever might happen.

2 the fed

3 new territory

Source: FOMC

Prior to the FED’s change in heart, there was this expectation that we are in for a global slowdown. After the FED changed its rhetoric, said they will pause to keep the economy up, stocks rallied after the bad end of the previous year.

So, a decline of 15% in the S&P 500 and a 100 basis points increase in the cost of borrowing for the US government, led the FED to stop with raising rates.

19 5 year trasury

Source: FRED

However, the FED capitulating means that the economy isn’t doing good at all because it cannot sustain small hikes!

6 end of cycle

Source: FRED

It is simple, corporations are too leveraged. US corporate debt has almost doubled over the last 10 years. The situation is similar across the globe.

7 coprorate debt

Source: FRED

Governments are too leveraged. Budget deficits are piling all over the place.

8 budet deficit

Source: FRED

Same situation across most of the modern world.

Now, you can tighten interest rates, but that will increase the cost of borrowing for governments, that will consequently force them to borrow more as no politician is going to save money and not spend.

Given the FED, ECB, BOJ and others are ready to do whatever it takes to keep things as those are, the only thing they know how to do is to give more of the same medicine, thus more debt.

NOW, let me make this simple – Q4 2018 – people were selling because of the FED, the economic data was good!

Q1 2019, people are buying because of the FED, the economic data is not that good!

2 truck orders

Source: Wolfstreet

3 italy recession

Source: Reuters

4 germany gdp

Germany

Source: The Independent

My conclusion is that there will be no more tightening, no more normalization because, over the last 10 years, politicians and central banks have seen that interest rates can be low and they are now like junkies on low interest rates.20 trump

Source: Twitter

How to invest and what to expect

I am looking at the data, I look at the FED’s and the politicians’ behaviour and I am thinking;

1) There will be more money printing, much more

The last recession unveiled a tool that hadn’t been really used before, it unveiled the possibility to use central banks’ balance sheets to help the economy. Before 2009, Central banks’ balance sheets had been mostly flat. After 2009, an explosion of money printing is what followed.

9 balance sheet

Source: FRED

We have already seen that governments and corporations went on a borrowing spree to take advantage of the low rates. As it is normal with both governments and corporations, there is never the intention to pay back the debt, their only goal is to make money on the spread between what they are earning from the capital used and the interest rate they have to pay. For example, Apple can borrow at an interest rate of 3% on a 10 year bond, if they use that capital and make 5% on it, they make a lot of money. Debt repayment? Don’t joke, you might kill someone with unstoppable laughter.

With governments, it is even worse. US interest expenditures had been stable as interest rates had been declining and stood low. However, as the FED started tightening, US interest expenditures exploded and given the current budged deficit, higher rates would make the payments unbearable. The usual definition of a Ponzi scheme is when one has to borrow just to pay the interest on the debt.

If interest rates increase by just another 100 or 200 basis points (1 or 2%), the interest payments of the US governments would make most of the budget’s deficit and would force the government to borrow to pay interest expenses.

10 government payments trasury

Source: FRED

What does this mean for the long-term? Well, the FED can control rates until a certain moment, at some point it all breaks down like a house of cards. Interest rates go up because who wants to lend money to a government or corporation that is borrowing just to pay the interest, inflation creeps in as people want to spend their money and the FED has to hike to stop the inflation while still printing to save the economy.

2) Be a debt owner, not a debt holder

Debt holders are the suckers, thus all diversified portfolios like my friend’s portfolio with an investment bank is, will see their values erode. Do you know that in the 1970s, bonds were called certificates of confiscation as inflation would eat up most of their yield?

news portfolio

Source: $13 Million Dollar Portfolio Analysis

Or, any other pension fund in the world will be in trouble too. While working in the Netherlands I did have a pension fund, ABP, where the top investments are government bonds, of course.

11 pension funds

Source: ABP – Dutch pension fund

3) Stocks might do well

However, the situation gets tricky with stocks as those are businesses and businesses, the good ones can transfer price increases, i.e. inflation to customers. A good example is the Argentinian stock market. From February 2008 the Argentinian stock market increased 17 times.

12 argentina

And you thought the S&P 500 did well?!?

However, the Argentinian Peso did almost the opposite against the dollar.

13 peso

So, prepare for a currency collapse down the road. It might happen tomorrow, it might happen in 2029. Whenever it happens, if you are not prepared, you are the sucker and you might lose it all.

4) The world will continue spinning

People often forget that the world will go on, the currency environment might be different but emails will still be sent. The cost might be different.

A good illustrative example is a normal postal stamp in Italy. The price in 1958 was 25 lire while in 1998 was 800 lire.

16 italy 2

The current price is EUR 0.95, thus 2000 lire. So, over 60 years, the price of sending a letter in Italy increased 100 times.

17 current price

The problem is that it will not be linear, it will be explosive so that will take many by surprise most. What to do? Well invest in great businesses, we will talk about one tomorrow, Disney, you can invest in commodities, we will talk about that on Monday with zinc, Glencore, Teck, Anglo American and you can make money on inflation, or at least stay protected as we discussed in the video on inflation this week.

My focus now is on businesses we can’t live without. That will give me protection over the long term, looking at margins of safety and healthy business returns.

If you enjoyed this video, please subscribe to my newsletter with a weekly content overview, that will give you the content you seek.

 

Stock Market News – The FED, Interest Rates and How to Invest

Good day fellow investors,

The news this week was all about the FED as the FED’s chairman made a speech and their meeting minutes came out on Wednesday. The market reacted extremely positively to the news and new rhetoric.

1 s&P 500

Up 1.55% on Monday, 2.3% on Wednesday.

Something very important it that we have to always do is to differentiate between the FED’s rhetoric and what they will actually do. As we have seen this week, what the FED says has a big impact on markets and changes the economic environment.

So, the FED must be very careful about what and when it says something. Let’s give a quick overview of what has been said and what has been done and then discuss and explain the implications of it.

The topics:

  • Powell’s dovish speech
  • FED’s meeting minutes
  • Economic data
  • Investment risk reward outlook

On October 3 2018, Powell said the following:

we’re a long way from neutral at this point, probably.

This week he said this:

interest rates are “just below” a range of estimates of the so-called neutral level

And this is very important for asset values and the economy! Let me explain:

Everything starts in the economy based on where interest rates are.

2 20 years interest rates

Source: FRED

Why is this so important for the economy and asset prices? Well, first about the economy. People have unfortunately already a lot of debt, be it student debt, mortgages, car loans or credit card loans. Now, if interest rates go up, debt becomes more expensive and consequently interest payments rise and there is less money available for spending.

For example, I have plotted the 30-year mortgage interest rate against the FED’s funds rate.

3 mortgage rate

Source: FRED

You can see how if follows the FED’s rate but what is important is that since the FED started increasing rates, the 30-years mortgage rate went from 3.5% to the current 5%. This means that the cost of a mortgage increased 42% which is huge.

The following chart shows how closely correlated those things are.

4 mortgage rate

Source: FRED

Now, why are Powell’s words so important. Because he now said the neutral rate will be closer to the current level of 2% than what was previously expected, closer to 4%. That 2% difference in the normal rate, makes the difference between a 5% mortgage and a 7% mortgage which is an enormous deal as people have more money to spend elsewhere and the economy doesn’t suffer.

Why did Powell change his rhetoric? Economic data

A look at the FED’s minutes show how they are watching what is going on and allowing for flexibility.

Concern on debt, leveraged loans.

11 debt

The last economic date has been showing weakness signals and therefore the FED changed their rhetoric not to lead the economy into a recession immediately as they usually did in the past. To say it again, when the FED increased rates, usually a recession followed.

The economic data came from various sources.

Home prices have slowed down in growth.

6 home growth

Source: WSJ

Why is this so important, because the economy is based on debt and asset prices going up, a decline in home prices would quickly lead to a 2009 situation.

But, perhaps the most significant information related to the economy is the following.

GM is cutting jobs in order to prepare for a slowdown in the cycle. You can do whatever you want but you can’t fight market cycles.

closing

Even the extremely bullish IMF downgraded its global outlook.

7 global downgrade

Source: Bloomberg

Also, something that summarizes an economy, are business equipment orders, not growing despite the tax cuts and stimulus.

8 equipment orders

Source: Bloomberg

How to invest in this environment?

Now, with everybody yelling that the FED will start the next recession, the FED is changing its policy to not be the one starting a new recession, what happen in the past will not be the next trigger, it is always something new.

Nevertheless, by lowering the normal rate, the FED is going along with the populist policies across the globe as you cannot be the only idiot tightening. So, things will be going along as they are going until they stop going and currencies go to hell. Be careful when owning bonds and business that cannot transfer price increases to customers and business that are alive just because of low interest rates.

For example, car manufacturers in Europe that can borrow at 0%:-)

I am investing in commodities, good businesses that will survive cycles and inflation.

On the economy

It is clear that it is so dependent on stimulus, both fiscal and monetary and that is how it is. One day, the FED and politicians will lose control because they are not allowing for a natural cyclical economy A recession is good as it eradicates the bad. However, bankruptcies are at historical lows.

9 us bankruptcies

Source: Trading Economics

Lower interest rates will make it easier to pay off debt, but we are just postponing the inevitable and making it harder down the road. One day, inflation will knock on our doors, be ready, be hedged and have a long-term mortgage again if the opportunity knocks with a 3.5% 30 year mortgage.

Keep reading, we will simply continue with what we do on this blog, looking for great businesses that are going to do well no matter what happens in the economy and we are going to look for value across the globe and buy when we find it but we will always keep in mind the risks out there.

Receive a weekly overview of published articles, videos and research reports straight to your inbox for boring long-term investing knowledge!