The Stock Market Vs a Chess Game

The stock market is in some ways much like a chess game – prices of stocks usually are priced based on future expectations. In other words the folks at multi-billion dollar hedge funds have done the math, and have tried to play a long ways into the future. This can be said about the price of stocks, and the price of stock derivatives. The biggest reason why the stock market has been falling in recent weeks is due to the expectation that the Federal Reserve is going to raise interest rates – a low jobless claim rate cause stocks to sink faster because it increases the chances that the Federal Reserve will in fact raise rates to stave off inflation. By doing so, stocks are no longer as good of an investment relatively speaking compared to cash – stocks have risk and cash has little risk, so to increase interest rates means you can get more return for a no risk investment.

However, since the stock market looks to the future there is a very real possibility that stocks will have taken into account a Federal Reserve interest rate increase before the increase happens – and if the increase is lower than expected you should see the stock market start to jump back up due to its factoring error.

That being said, investors should still reassess the forward price earnings ratios of their stocks to make sure they aren’t holding on to something that is too expensive. Speculators will still hold onto company stocks which they see as having lots of potential even though they are priced very high. You can see that in companies like Tesla, where a company that doesn’t have a P/E ratio because it isn’t profitable yet still boasts a good stock price. On the other hand, a company like AFLAC has a very low P/E ratio of 10 because I suppose investors don’t see AFLAC coming up with the new invention of the century. Apple is priced at a moderately cheap price of around 15, as investors are weary that Apple may have had its day in the sun and won’t come out with any new revolutionary products since legend Steve Jobs has left.

My suggestion then is to sell off your expensive stocks and as the market drops incrementally buy back in as prices because attractive. As an insurance policy against the Federal Reserve deciding not to raise interest rates I suggest buying some precious metal company stock, and companies that will do well under higher interest rates include banks such as Bank of America. I want you to be the one who yells Checkmate before your portfolio yells it to you!

Please make sure to read my disclaimer below before taking any action.

How Does Greece Affect the US Economy?

Greece in and of itself does not directly do much business with the United States. Greece does not have manufacturers that compete with the US, such as S. Korea, China, and Germany have. Greece does, however, greatly impact the European Union not only because of the size of its economy but more importantly due to the thought of a collapsing EU. The EU (European Union) was created in 1993 and has 28 member states. If Greece exits, it will raise the spectre of other economically weak countries like Italy and Spain leaving – this will shatter the Euro and send investors running for the hills. It will make the US dollar much stronger which will hurt US exports, which in turn will affect US international companies negatively. It will also hurt US tourism as it will be much more expensive for Europeans to visit the United States.

The thought of a collapsing economy and certainly the fact that Greece has stopped people from withdrawing their money from their own bank accounts may have a ripple effect across other countries in Europe and possibly the world. The 2% drop in the Dow Jones on Monday and the 2.5% drop in the Nasdaq does not bode well for an actual Grexit (The new term used to describe Greece’s exit from the Eurozone). Stock markets that are already priced too high in terms of price earnings ratio will feel more pressure to correct themselves. A falling stock market means less market capitalization in companies which is used to fund their operations, which may in turn lead to job losses. The stock crash of 1929 led the way for the Great Depression in the United States, which is an extreme example of what happens when a stock market crashes.

If a stock market crashes then confidence is lost, and the likelihood of new jobs is dampened.

 

Reading the above you might think it’s time to head for the hills, but I think that a more important and less pronounced threat is the United States debt and trade deficit which will not be helped by a European crisis. Ways to protect yourself include but are not limited to:

  • Shifting out of stocks and into cash, whose value will most likely increase relative to the rest of the world unless the Federal Reserve doesn’t increase interest rates and comes out with another stimulus package
  • Making sure that your portfolio does not include European investments

Of course, these protective measures may limit your upside potential, but will most definitely defend you against a downside. If you’re courageous enough, you can always short individual stocks. Please read my disclaimer below and have a nice day.

Ignore Most Market News

The average stock investor should avoid most news stories related to stocks. The reason I say this is that many times people have emotional ties to gains and losses and tend to make far too many transactions for what is necessary based on reading a barrage of market news, which is a entire industry unto itself. I recently commented on how inconceivable it was for the price of oil to hit $10 per barrel, but that kind of news made headlines. While people were heading for the hills, I decided to and taught readers how to invest in oil using ultra ETFs. Now Brent crude is trading at $63.31 and those who had shorted oil when it was less than $50 per barrel would be feeling the pain.

Now the key word here is ‘most’. Many folks try to make a name for themselves and their product by claiming outrageous things trying to build publicity for their name and if the off-chance they’re right it was all worth it! Well, if they’re wrong then they’ll just stay quiet for a few months. There are, on the other hand, reasonable financial advisers who will make thoughtful suggestions about the state of affairs.

My suggestion is this:

The stock market is overpriced, a historically good bet but given current P/E ratios it’s just a matter of time before the market falls. The timing on that fall is between now and 1 year from now. The correction should be between 10 to 20%. Many people should be looking forward to this correction in order to bolster their portfolios at a discount.

Oil has taken a hit but is on a comeback. We will probably see the price of oil rise in a few months – possibly due to global conflict.

To act on this would be to simply sell stocks and buy oil.

Make sure to read my disclaimer below.

6% Chinese Stock Market Drop

On October 28th, 1929 the Dow Jones Industrial Average fell 12.8%.

On May 28th, 2015 the Shanghai Composite Index dropped 6.5% – the largest fall since 2008.

The Wall Street crash took place after a period of speculative buying where many Americans were borrowing money to invest in stocks. The same can be said about Chinese investors, and to a lesser extent American investors as of late. As P/E ratios drift higher and higher, or non-profitable company stocks start to rise, it’s only a matter of time before the market gets overheated. Considering many of these investors are using borrowed money, the risk of sudden downturn is higher – Margin loans must be called if account balances get too low, and burned investors will not be able to get back in the market.

Whether the 6% drop is a prelude to something bigger is yet to be seen – but keep in mind the market in China does not allow single shares to go down more than 10% in a single day, which means we may see a further drop tomorrow. This will in turn put stress on Chinese investment banks and will have a trickle down effect on the Chinese economy. If mom and pop investors are all putting their life savings in the stock market do you think they will spend as much on the street as they used to?

Anyways, this is all speculation, but I think it’s safe to say we are going to be seeing some pretty interesting financial news come out in the next few months.

The Most Powerful Force in the Universe

E = mc²

E = mc²

Albert Einstein

Mass energy equivalence paved the way for our most powerful weapon and energy source. Nuclear force was not, however, the most powerful force in the universe according to this man. Instead, it was compound interest.

Einstein was a man of relativity, and while it is true that nuclear is the strongest type of force taught in the classroom, in the real world his statement makes a lot of sense. The top 1% of income earners will make much of their income off of investments, and these investments typically yield a certain percent of profit per year which is then applied back upon itself the next year. This is one way in which income inequality grows – because the lower wage earners do not put their money in compounding investments.

It is important for anyone looking to get the highest return on their investment to understand the basics of compound interest.

Rule of 72

For those that don’t want to pull out a calculator to find out how long their investments will double in size there is a helpful and speedy way of figuring out roughly how long it will take to double their money. Divide 72 by the interest rate and that will be the number of years a annually compounding investment will take to double. See examples below:

9% interest – 72/9 = 8 years

5% interest – 72/9 = 14.4 years

3% interest – 72/3 = 24 years

If you use outrageously small or large interest rates the rule of 72 starts to break. Obviously a 100% interest rate will double your money in just 1 year, not eight and a half months!

Compound Interest Formula

The mathematical formula for annually compounded interest is

FV = PV * (1 + i)ᵗ

Where FV is future value, PV is present value, i is the interest rate, and t is the number of years. As most readers know, this is an exponential function of time (See Figure Below).

Solid line is exponential function with lower constant value.

Solid line is exponential function with lower constant value.

As you can see, exponential values can quickly get out of hand. Other real world examples of exponential growth include population growth in developing countries, inflations affect on currency (exponential decrease in value as seen below).

How inflation eats away

How inflation eats away

The phenomenon known as the rising income gap comes largely from these two graphs. The top graph represents invested wealth and the bottom represents buying power of a single unit of a depreciating currency.

What do I do?

If you’ve read to this point then you’ve already taken a good first step – you’re searching for knowledge and exponentially growing your financial acuity rather then let your mind exponentially waste away. I suggest creating a financial plan which takes into account your age (time till retirement), risk tolerance, and net worth and allocate uninvested funds into investment accounts. Investments can range from stocks, bonds, real estate, and even high interest savings accounts. Keep in mind that these days interest rates are amongst the lowest in mankind’s history, in the United States in particular. Most of all, don’t panic!

How To Prospectus Hunt For Stocks

Some investors are clueless when it comes to investing in stocks per industry. There is a way to take out a lot of the hassle of opening financial reports and studying the growth patters of companies – have someone else do it for you! You can hire a portfolio manager or you can buy ETFs which manage a portfolio in your desired sector for you. Another, cheaper, alternative is to simply Prospectus Hunt.

I will be using PHO as my example today – PHO is a water industries based ETF which according to their description:

PowerShares Water Resources Portfolio (the Fund) seeks investment results that generally correspond to the price yield of the NASDAQ OMX US Water Index (the Underlying Index). The Fund generally will invest at least 90% of its total assets in common stocks that comprise the Underlying Index. The Underlying Index seeks to track the performance of the United States exchange-listed companies that create products designed to conserve and purify water for homes, businesses and industries. The Fund invests in the sector such, such as industrials, utilities, healthcare, information technology and materials. Its investment advisor is Invesco PowerShares Capital Management LLC. [1]

Creating products that are designed to conserve and purify water sounds like a pretty noble and lucrative business. I want to take part. The easiest thing to do is obviously to invest in PHO, however if you read their prospectus closely you will notice an “expense ratio” of 0.61%. This is actually a bit higher than the industry average expense ratio of 0.44% for ETFs, and a bit lower than the standard 0.74% expense ratio for index funds. For those who don’t know what expense ratio is:

Expense ratio is the percent amount of your holding that will go towards the fund manager every year. For example if you have $1,000 in an ETF with an expense ratio of 0.61% then you’re going to be paying $6.10 every year to the managers of the fund. Most funds have their holdings listed publicly on their website – Currently PHO has the following as their top stock holdings:

  • WAT      Waters Corp
  • ROP       Roper Industries Inc
  • PLL        Pall Corp
  • PNR       Pentair PLC
  • FLS         Flowserve Corp
  • MWA      Mueller Water Products Inc
  • ITRI        Itron Inc
  • WTS        Watts Water Technologies Inc
  • TTC         Toro Co/The
  • WTR        Aqua America Inc

 

Now that you have a nice list at your disposal the only thing left is to pick a few of these stocks to invest in. Look for standard things, like P/E ratio, growth, current events that make the company appetizing and go for it! Doing this will usually leave your investments more volatile as you will have less diversity but eliminate the expense ratio for each year and enable you more control over your investment make-up.

If you’re interested in different types of ETFs a have a few that you can pick from below:

  • USO (Oil)
  • PPA (Aerospace and Defense)
  • IDU (Utilities)
  • GLD (Gold – keep in mind that ETFs may not hold stocks but may instead hold physical commodities such as gold)
  • SLV (Silver)

 

Good hunting.

 

References:

[1] Invesco Distributors, Inc. “Product Details.” PHO – PowerShares Water Resources Portfolio. Invesco Distributors, Inc., n.d. Web. 16 Apr. 2015.

What Explains the Chinese Stock Market Price Boom?

The Chinese stock market boom has been scrutinized by the US mainstream media for it’s rapid ascendance. You will hear people mentioning that high school dropouts are now investing in large numbers without understanding the basic fundamentals of companies including but not limited to earnings. The Hang Seng (Hong Kong’s Market) has risen 60% this year having been opened up to sell shares to Chinese investors.

In all reality, small scale investors make up a small portion of actual market volume – and while it’s true that a large number of them are trying to get in on the action, the real reason for this steep rise is a law change which hampered real estate investment tactics. This included increasing the minimum down payment on a second property to 20% and increasing the capital gains tax on property sales to 20%. If you’ve lived in Asia you will find out that Chinese investors are big into real estate – and this spreads beyond China and Hong Kong into other ASEAN countries including Australia and New Zealand. Even less educated folks know the value of owning property, and many of them have been fortunate to make a reasonable amount of money in the past few decades as China has progressed to claim the world’s #2 spot economically speaking.

Stack the new property restrictions with two interest rate cuts by the central bank and a specter of a stimulus package down the road and you have the perfect environment for a stock market to flourish. This is similar to how the US stock market has reacted in the past few years to the Federal Reserve stimulus packages and extended periods of historically low interest rates.

Just this week, the Hang Seng market value rose above Japan’s Nikkei – an amazing feat but not unexpected given their market getting opened to Chinese mainland investors. Japan continues to stagnate as its fundamentals and workforce are burdened by a low growth rate and near zero immigration (due to strict immigration laws). The one bright side to the economy these days is higher tourism due to a stronger dollar against the Yen.

Some imagine the Chinese and Hong Kong bull markets will continue for awhile until free cash flow diminishes. Others are more skeptical, including most US pundits – they envision a large correction. I can foresee a huge catastrophe if the tax laws are changed regarding Chinese capital gains tax on stocks, but given the new restrictions on real estate trading this isn’t completely out of the question.

In hindsight, an American investor could have made a fair amount if he/she invested in Matthews China Fund Investor Class (MUTF:MCHFX), which has gone up 20.17% Year To Date. This fund specifically zoned in on Chinese stocks has outperformed one of the best American stocks Apple (Apple has gained 12.96% year to date) and NASDAQ (A piddly 4.57%). Investors can also consider investing in a broad array of Asian dividend stocks using the Matthews Asia Dividend Fund Investor Class (MUTF:MAPIX) which has gone up 12.95% YTD.

It goes without saying that the one who thinks there’s a serious bubble can always short these types of securities, but this is EXTREMELY risky. There is still more free cash flow as a percentage of the stock market capitalization in China than the US, meaning that they can pump a lot more money into the stock market before running short on liquidity. My expectation is that if the Chinese stock market is reaching bubble capacity and collapses, it’s quite likely to impact the US stock market. Even from a psychological perspective, seeing a bubbled stock market pop may cause people to rethink their investments.

Investing in Silver

Silver is a pretty common metal in the world – it has many industrial uses due to its highly conductive and reflective properties. In fact, silver is the most thermally conductive element!

Silver also has a lustrous quality, until of course it oxidizes – this phenomenon is called tarnishing.

Silver has been used in coinage since at least 700 BC, when the Lydians used a naturally occurring silver-gold alloy to mint these coins. Concurrently, the Chinese also used silver in their coinage.

Today, silver can be invested in directly through the purchase of silver coins or bars which can be classified into bullion, collectibles, and antiques. Bullion is silver stored in a very simple form like a plain bar with a simple seal of the minting company on top. Collectible silver coins can include nationally minted coinage such as the US American Eagle, the Canadian Maple Leaf, or the Chinese Panda. These nationally minted coins are more valuable than bullion because they are easier to recognize and differentiate between genuine and fake products. That being said, the only true way to test silver is to perform an acid test, as today there are very skilled copycats which use lead and other inferior materials to create realistic looking fakes.

If you are going to invest in silver, make sure you are buying from reputable sources – I would not encourage buying from an online store that does not sell large quantities. I would also stay away from vendors on the street anywhere in the world – ensure that your seller has a brick and mortar business if you are going to buy face to face. Also, make sure not to buy silver that is overpriced – Bullion should not be selling for more than 5 percent more than the “strike price”. Strike price means the current world market price. In some countries, however, it’s hard to get around paying a large premium if the government imposes high import taxes on such goods. India, for example, has a huge import tax on gold and silver.

Silver bullion is usually sold in 1, 5, and 10 ounce pieces. This makes future transactions much easier.

If you are interested in buying collectibles, then you are effectively buying an insured piece of history. This is similar to buying collectible coins but for the vast majority of historical coins the silver/gold ones carry a much higher premium. For example, a simple old Roman coin might cost you $50-$100. A silver Roman coin will run you more like $250-$1000. I can’t claim to be an expert on the value of historical coins, but these types of investments can be a lot more risky than investing in simple bullion.

Historically, silver is not a good investment as compared to stocks or bonds. Silver will not pay you interest, it does not work to create earnings, and requires the cost of storage. However, under certain circumstances most recently the stock market crash of 2009 investing in silver or gold until the stocks dipped by 50 percent was a damn good deal.

Financial Planning 101

Financial planning is often necessary for people to realize their life’s goals without having to worry about being short of cash. Financial planning may be necessary to save a sinking ship of personal finances, and financial planning can be done by anyone with the willpower, organization, and intelligence to draw up and execute such a plan.

Smart financial planning doesn’t only consider how to have the most money by the time you die, but actually have the best quality life with the amount of money on hand while saving enough to avoid external risks.

The first step in a solid financial plan is making sure personal income less fixed and variable expenses is positive. If this doesn’t happen none of the other steps really make sense – if you don’t have any savings you really shouldn’t be investing in risky stocks – for example.

Tools to accomplish this include making a budget, getting a good education in order to get a good paying job, and cutting spending. A good financial planner will accommodate to the needs of his/her clients and make changes to a plan as necessary. Sometimes budgeting is unnecessary for certain individuals who have a track record of modest spending vs. their income, at these times budgeting can really be a waste of time. Other-times, however, budgeting can point out significant spending patterns that the client might not realize are eating into his savings. Having a Starbucks every day, for example, will eat into your savings. Eating out expensively every day can eat into your savings.

After making sure your budget aligns with a healthy financial future, it is the job of a financial planner to make sure that their clients are protected against the unforeseen. Do you have health insurance, do you have disability insurance, do you have a rainy day fund bank account that you do not touch unless there is an emergency? A rainy day fund typically should be six months of expenses – unless the client has a working spouse in which case that duration may be cut in half.

A rainy day fund is something that can be used if you are unexpectedly terminated from your job – the amount of such a fund is based on your fixed expenses. If you make 5,000 MYR per month and spend 3,000 then your rainy day fund will be a bit less than 18,000 MYR. I say a bit less because costs associated with getting to work can be subtracted. In the US less than 1/4 of medium income earners have at least 3 months saved based on information from bankrate.com.

Once a rainy day fund is established the fun part starts – getting saved up for kids’ educations and retirement. Choosing investment portfolio allocations along with real estate advice, along with tax advantaged strategies. In the US financial planners sometimes recommend putting money into tax advantaged 529 plans, which are based on a stock market portfolio that when cashed out for college doesn’t need to pay capital gains tax. Malaysia has something called SSPN managed by The National Higher Education Fund Corporation.

According to the SSPN website : “The National Education Savings Scheme (SSPN) is designed especially by the National Higher Education Fund Corporation to enable parents/guardians to save for the purpose of the higher education of their children.” I wont be getting into the details of this Malaysia specific scheme but if paying for your child’s education is something you’re interested into it is advertised to pay higher interest than regular bank accounts.

At the end of the road for financial planners it is time to consider how a client wishes to pass on their assets or estate to heirs or anyone/anything of their choosing. This usually involves writing a will and managing gift taxes that are in play in the client’s respective country. Luckily for Malaysians there is no death tax, for people in the US sometimes if they wish to benefit their relatives or “heirs” they will create education 529 plans for grandchildren and fund them all to the max, along with giving away money before their death up to a certain threshold. In the US as of last year the exclusion amount is 5.34 million USD.

So really the job is pretty straightforward from an outside perspective. Keep people from becoming broke throughout life – make money a non-issue so clients can enjoy life.

Frivolous Purchases and You

If you’ve read the tech news lately, you’ll know that Apple is going to release it’s Apple Watch on April 24th in Australia, Canada, China, France, Germany, Hong Kong, Japan, the UK and the US. The most surprising and talked about subject about the release was the price on it’s Edition series of watches, which will range in price from $10,000 to $17,000. These watches are made of 18-karat gold which Apple claims to be developed to be “twice as hard as standard gold” and sport the sapphire screen. While these watches look “nice” they are certainly still pieces of technology. The funny thing about technology is that it depreciates much faster than other durable goods – faster than a mahogany piece of furniture, for example. I’d expect digital technology products to depreciate faster than mechanical products of a similar type (for example a Rolex watch).

If one spends $17,000 on a Apple Watch – a watch that starts out at around $350, then one should expect the rest of the watch to be worth at least $16,000 – which it is not. You’d be able to buy more than 12 ounces of gold for this price. The gold portion of the watch is not described to be compatible with newer versions of the hardware, so when the Apple Watch 2 comes out the value of your watch probably goes down by around $10,000!

As someone concerned with you making the most of your money, while still enjoying life, I would not suggest buying a Apple Watch Edition. Go ahead and splurge a few hundred dollars on a piece of technology if if will, but $17,000 is a fools purchase.