Stock Market is often disconnected from the real economy

For years, I have seen many stock market bubbles form and then burst. Stock market experts seem to sing the same old tune. They are looking beyond present conditions toward what they believe will happen in the future. Bubbles usually form when there is too much optimism and tend to burst when the economic reality sets in.

The basic human suffering from Covid-19 gets more and more insane by the day. The reality on the ground is that the spread of Covid 19 is getting worse in the U.S. and other parts of the world, not better.

Why then have money managers continued to push stock prices higher?

  1. They believe that whatever is happening today doesn’t matter, but it is where we are going tomorrow that matters.  In this case, tomorrow is 2021.
  2. Government stimulus measures seem to have lessened some investor fears. The CARES Act, the $2.2 trillion coronavirus relief package issued one-time stimulus payments to American households. It expanded unemployment benefits and created a forgivable loan program for small businesses.
  3. The Federal Reserve has also used aggressive measures to make sure businesses and municipalities can access ready cash.
  4. Investor optimism has been buoyed by phased state reopenings that have begun across the country and the expectation of a vaccine.
  5. There has been a rebound in consumer spending and some companies are rehiring.
  6. A survey of financial advisors suggests they’re taking a rosy view over the long term. A quarter of advisors expect to increase their stock recommendations to clients over the next year.

Here is a dose of reality

It turns out that much of the S&P 500 returns come from just 10 companies: Microsoft, Apple, Amazon, Google, Facebook, Visa, Mastercard, Nvidia, Netflix, and Adobe. As a group they are up 35% since the beginning of the year. As a group, the other 490 are down more than 10%.

Just three stocks make up more than a third of the Nasdaq 100 Index. I bet you can guess which three. Apple, Amazon and Microsoft together are now valued at nearly $5 trillion. That’s larger than the entire economy of Germany and nearly the size of the Japanese economy

In a true bull market, you see most stocks rising, often to new highs. A rising tide should lift nearly all boats. The percentage of NYSE stocks closing above their 200-day moving average is only 37% but it was near 70% in January.

The market has already assumed that current earnings will be bad. Analyst earnings projections tend to overestimate even in good times and analysts tend to have a herd mentality, usually tracking one another. I found a chart by Jim Bianco to illustrate a possible valuation bubble.

 

The problem with stock market bubbles is you can never predict when they will burst. The most notable one was the dot com bubble that formed from 1995 to 2000 and burst in 2001. There are a few stocks today that are valued similar to some of the past dot com stocks.

Tesla is a perfect example, it has a market value of 262 billion based on sales revenue of 25 billion. You can also add Shopify to the bubble list that has a market value at 110 billion with only 1.7 billion in sales revenue.

Some economic reality may set in next week with the release of second quarter GDP on Thursday July 30. (Analysts are expecting a decline of 33%), along with Friday’s release of consumer spending, Chicago’s purchasing managers index (PMI) and consumer sentiment index.

 

 

Why interest rate cuts won’t save the economy or the stock market

This week, after an emergency call with central bank leaders around the world, the Federal Reserve cut interest rates. A somewhat surprising move coming about two weeks before its next scheduled meeting. It was the first emergency rate cut by the Fed since the financial crisis in 2008 and a strong signal that the central bank is taking the threat of the virus seriously.

The problem is that cutting interest rates, which were already very low, isn’t likely to do much to solve the kinds of economic problems posed by a pandemic.

Think of it like this: if more people get sick, more people can’t work. Businesses become less productive and ailing workers without paid sick leave don’t earn money. (They might also go to work sick.) Meanwhile, others who are either sick or afraid of catching the virus stop going out and spending money.

Restaurants, movie theaters, hotels and airlines have already experienced less revenue. More workers will lose their jobs temporary, so fewer people will have money to spend. Its classic cause of an economic downturn since the U.S. economy depends on consumers’ spending money.

Crucially, all the people out of work will still need money for food and housing costs. The new record-low mortgage rates aren’t going to solve that immediate problem, especially not for renters. Nearly 4 in 10 adults would have trouble handling a $400 emergency expense, according to a recent study from the Federal Reserve.

An economic downturn is coming, the problem is no one knows how severe it will be and how long will it last. China’s economy took a big hit and government took some draconian measures that can’t be done here in North America.

Some precautionary financial steps

  1. Top up your emergency fund
  2. Living pay check to paycheck: then get a line of credit or increase the limits on your credit cards
  3. Start looking for day care services in case of school closures
  4. Don’t put any new money into the stock market until the coronavirus is contained. (Too early to buy the dips, however make an investment shopping list)
  5. Get ready to refinance your debt, but keep in mind that there could be more rate cuts.

Why you shouldn’t panic over a decline in stock market prices

The chart below illustrate what happen to stock market values during the financial crisis. (Jan 2008 until Mar 2011) The left side of the graph shows the market hit bottom in Mar of 2009 and recovered most of it losses by Mar of 2011. I not suggesting that this current market downturn will get that bad.

Keep in mind that the stock market has gone straight up since the market hit bottom back in march of 2009 with a few little blips. The chart below illustrates that the current downturn could be just another blip. This virus will only have a temporary effect on the economy and consumer spending will recover. People will travel again, visit theme parks, eat out and business will be profitable again.

Back in September, I wrote a post to reduce some of your risk and move some money into dividend paying stocks. I hope that you followed my advice.  Dividend income should help to offset some of the fall in value of your portfolio.

 

 

 

Fall is a good time to do some tax planning

Being a retired senior, reducing income taxes is key when living on a fixed income. I usually joke with my friends that I fix my own income each year. I do my best to minimize my quarterly installment payments to the tax department.

With holiday season coming soon, you are going to be busy visiting with family & friends and Christmas shopping. You will be glad during tax filing season that you planned ahead! You could reduce your tax bill or generate a bigger tax refund.

Tip 1 – Add up your medical bills from this year and compare them to last year. If you have spent less, you may want to reschedule your dentist appointment from early January to December. Do you need new eyeglasses or hearing aids then buy them now. Planning a winter vacation that requires medical shots, get them ahead of time.

Tip 2 – Add up your charitable donations and compare them to last year. If you have donated less or nothing at all, now would be a good time to be generous. Wealthy people donate stocks, ETFs and mutual funds that have a capital gain instead of money. They don’t have to pay any tax on the gain and the full amount is tax-deductible creating a bigger tax deduction.

Tip 3 – Get out your lasts year’s tax return and see if this year’s income will be higher than last year. Will you be in a higher tax bracket? If yes, an extra contribution to your tax-deductible retirement account could generate a bigger tax saving. (Plus stock market returns have been known to be higher from November to April) If you are retired and your income is lower than last year, consider withdrawing a little extra from your retirement account and put it into a tax-free account.

Tip 4 – Have you sold any investments in 2019 that will generate a taxable capital gain?  Do some tax loss selling of investments that are underwater to offset the capital gains? In Canada, a capital gain loss can be carried back three taxation years to offset capital gains incurred in that year. You can always buy them back later. (You will have to wait 31 days to re-buy to avoid “superficial loss rules”)

Tip 5 – Postpone selling your investment winners in non-registered accounts until January to avoid paying tax in April. If you have losses, consider selling some winners and buy them back again to increase your cost base.

Tip 6 – Look for ways to legally split income by transferring income producing assets to family members that are in a lower tax bracket. For example, in Canada you can contribute to your spouses’ retirement fund and claim the deduction.

Tip 7 – Top up education savings plans for your children or grandchildren to ensure your plan gets any eligible government grants. (Canadian grants stop the year in which the child turns 18)

Tip 8 – Getting a big year-end bonus? It may be better to postpone getting it to January or have your employer deposit the bonus directly into your retirement account!

Tip 9 – Check to see if there are any changes to tax laws that could affect your tax return for 2019 & 2020. There could be some new tax deductions or some deductions that could be eliminated.

Tip 10 – Small business owners should go over their account receivables and make a list of potential bad debts. Consider writing off any bad debts that are more than 120 days overdue before tax season ends.

The tax man is happy to pick your pockets for more money. It is up to you to legally avoid paying them too much. Remember, rich people stay wealthy because they can afford the best tax specialist to reduce the amount of tax that they pay.

Do you have any year-end tax planning tips?

 

 

Is it time to switch from Bonds to dividend paying stocks?

What are the risks facing us in the next year or two? The inversion of the yield curve which has happen on three separate occasions has me worried. It signals more stock market volatility, it is a sign that the bond market fears subpar economic growth and that a trade war could cause a global recession.

Historically an inverted yield curve has been a reliable, though not perfect, predictor of a recession. Each of the last five recessions was preceded by the two and 10 year Treasury yields inverting. (the two year yield is higher than the 10 year yield)

So, is the Bond Market Insane?

We now have $17 trillion worth of negative interest rate bonds, mostly in the sovereign bond space. That is about 25% of the entire bond market and 43% of bonds outside the US. In simple terms, you buy a $100 bond but pay $105 for it and you are guarantee to get $100 back when the bond matures. Who in their right mind would buy an investment that if held to maturity would lose money?

There has never been such an animal in the classification of bonds. Until a few years ago, traders and investors around the world would have considered negative rate bonds as imaginary as a children’s fairytale.

Mark Grant wrote this about negative interest rates in Europe:

While the European Union is not creating “Pixie Dust Money,” at the ECB, and then buying their own nations’ sovereign, and corporate debt, to purposefully hurt the financial markets, or the United States, that is exactly the “collateral damage,” that they are causing. The nations of the EU cannot afford to pay for their budgets, or their social programs, so the ECB has moved down their borrowing costs to less than zero, in most cases.

Check out their 5-year sovereign debt yields:

Why I am reducing my bond holdings and switching to dividend paying stocks.

  1. Since I am retired, the recommended withdraw rate from my retirement account is 4%.  Interest from bonds are not meeting my needs.
  2. Dividend paying stocks will lose some value during the next recession but less than the overall stock market. Plus, I will get paid to wait for the stock market to recover.
  3. In Canada, the dividend tax credit increases my after tax return by 25% over bonds.
  4. The next recession could be extra long because Central banks have already lowered interest rates. They will have less tools to stimulate the economy when a recession hits.
  5. The yield of both Canadian & U.S. 10 year bonds are below inflation which reduces the value of money over time.

 

Telecommunication companies like AT&T (Ticker: T) and Bell Canada (Ticker: BCE) have dividend yields of 5.7% and 5.08% which are much higher than bond yields. Some Canadian banks also have dividend yields in the 5% area and they continue to raise them. (ticker symbols:  BNS & CM).

These are not recommendations but examples to illustrate that they are a wide variety of dividend paying stocks with higher yields than bonds. They are not recession proof but do provide a steady income stream. Keep in mind that even cash isn’t safe because inflation will over time reduce its purchasing power.

 

 

 

 

 

 

 

 

Making a new budget despite a failing budget in 2018

Image result for budget

 

You would think that a former financial planner could put together an accurate budget. Unfortunately, the best-laid plans of mice and men often go awry. (This saying is in “To a Mouse” by Robert Burns)

No matter how careful I am in planning a budget, something may still go wrong. My central air conditioner failed last year even though it wasn’t that old. Plus, I didn’t realize that the life cycle of my stand up freezer is only 10 years and that hearing aids need to be replaced every 4 to 5 years. Replacing all these items was not in my budget and very expensive.

However, my emergency fund did cover other unexpected break downs like having to replace my old treadmill, workout television and to buy a new refrigerator. Needless to say, 2018 was a year of unforeseen expenses.

Projecting my retirement income for 2018 also missed it mark. Some of my Canadian dividend stocks cut their dividends which not only reduced their payouts but caused their share value to drop.

I offset some of my lost income by doing some tax loss selling which will generate an income tax refund in 2019. Plus my new hearing aids are tax-deductible which makes their purchase a little less painful.

Some tips to avoid budget failure

  1. Don’t guess, there are plenty of ways to track your spending. (Internet banking, credit card statements, mobile apps just to name a few.

  2. Don’t forget to include birthday, weddings and Christmas gifts in your budget. You can rack up credit card debt by unplanned gift giving, especially during the holidays.

  3. Have a realistic emergency fund. Too many people live paycheck to paycheck. For example; the U.S. government shutdown is not only hurting government employees but contract workers who won’t get any back pay. One solution if you have trouble saving is a low-interest personal line of credit which is better than using your credit card for emergencies. 

  4. Your budget should be flexible, it isn’t written in stone. It isn’t something to keep you from spending moneyA budget is a tool to provide you with information to manage your finances. It can help find money that you can spend where it will give you the most enjoyment.

  5.  Think of a budget as a money road map. Sometimes you will come across bad weather, road closures and construction detours. Don’t give up if your budget doesn’t work out the way you planned.

It’s always a shame when you work hard and don’t get any benefit from the money that you have earned. Get in the habit of making a budget every year. Life is too short to live paycheck to paycheck.

Robo-advisor vs. human advisor

The robo-advisor platforms offered by companies like Wealthfront and Betterment are gaining in popularity. The low cost of investment management services is very attractive when compared to fees charged by human financial advisors. It leaves me wondering if financial advice from humans is on its way out.

Advances in artificial intelligence has already replaced some money managers at companies like Blackrock. Last October marked the debut of an AI powered equity ETF. The exchanged traded fund is run by IBM’s Watson, in other words, the new portfolio manager is a computer program. Most ETFs are passively managed and follow indexes or specific sectors in the S&P 500. The AIEQ ETF is an actively managed security that seeks to beat the market.

Here are four advantages that traditional advisors have over robo-advisors.

  1. Human emotions

Robo-advisors only have one job, to use algorithms to manage your investment portfolio. They are not designed to manage the emotional component of investing and building wealth. For traditional advisors, this is a daily role they fulfill. When markets decline or clients experience an important financial event, the traditional advisor is there to talk them down off the proverbial ledge and help them make a rational decision void of strong emotions.

  1. Accountability

Many people are capable of holding themselves accountable on their own but having someone else committed to helping you in the endeavor only ups your chances of success. Computers are certainly capable of creating tasks and sending you reminders but they have little to no flexibility in helping you devise an accountability system that truly works for you and is tailored towards your specific goals.

  1. Flexibility

Let’s face it; over time our lives can change quite drastically. You get married, have kids, buy a house or become unemployed. The list goes on and on. Each of these events creates what we call “money in motion.” When money is in motion, planning, adjusting and taking thoughtful action needs to occur in order to ensure a positive outcome. Over time, many discussions are required during this process and having a human expert helps you adjust and adapt as needed.

  1. One-size-fits-all vs. tailored service

Part of why robo-advisors are cheap, relative to financial advisors, is due to the fact that they are a streamlined, automated service. As great as this can be, it also creates a lot of limitations. Rather than being built and catered specifically to you and your current financial situation, robo-advisors are designed to serve the masses. This means a somewhat cookie-cutter, one-size-fits-all approach in their offerings.

Traditional advisors, on the other hand, can tailor the services and investment management style they provide according to your unique financial situation. (Insurance coverage, debt reduction, tax plan & estate planning)

Having worked as a financial advisor, I am somewhat bias and prefer the traditional advisor over the robo-advisor. However, a robo-advisor provides a service to a select group of clients and financial advisors provide services to a different group. Each cater to the preferences of their unique clientele.

 

 

Trudeau is whistling by the Canadian graveyard

According to Wiktionary:  “whistle-past-the-graveyard” is to attempt to stay cheerful in a dire situation; to proceed with a task, ignoring an upcoming hazard, hoping for a good outcome.

In my humble opinion, this idiom describes our Prime Minister perfectly. The Canadian government missed a golden opportunity to respond to the Trump tax cuts in the February 2018 federal budget.  The United States, our largest trading partner, has made investing in the U.S. more attractive than Canada. Corporate tax rates in the U.S. are 5% lower than Canada and more important is the 100% deduction for new capital spending.

The Canadian dollar has fallen in value from $1.2586 at the end of February to $1.3079 today. A clear sign that foreigners are taking their money out of Canada.  The uncertainly regarding the successful re-negotiation of NAFTA is hurting our dollar and is also responsible for the lack of capital spending in Canada.

Our factors that make Canada less competitive than investing in the U.S.

  • Carbon taxes have increased energy costs.
  • February budget increased taxes for small businesses and individuals.
  • Canadian oil is being sold at a discount by $20 to $25 a barrel costing billions of dollars in lost revenue to Canadian oil companies and loss of tax revenue.
  • Kinder Morgan’s Trans Mountain pipeline expansion is being delayed by protesters.
  • Many LNG projects have been scrapped. Meanwhile, this sector is booming in the U.S.
  • The housing market is slowing down due to a 15% foreign buyer’s tax, tightening mortgage rules and higher mortgage rates.
  • Tariffs on softwood lumber, pulp & paper and solar panels. (Steel & aluminium tariffs could become permanent if Trump doesn’t like the NAFTA deal)

No surprise that the Toronto stock exchange is down 4% year to date while the S&P 500 is flat and NASDAQ is up 6%. The Trump tax cuts have already boosted employment and capital spending should kick in the second half of 2018. However, there are still are plenty of risks investing in the U.S. with the Trump circus in Washington. Possible trade wars leading to inflation and higher interest rates.

It is going to be very challenging to make money in 2018!

I am still a Canadian Bear

Market crash or correction could be a good time to buy

 

 

My blog post last week warned of a possible correction due to Trump’s future withdrawal from NAFTA. I believed that a pullback was in the cards but you never know what will trigger a sell off.  The pullback started to get some steam on Thursday afternoon when the Atlanta Fed released their projections for first quarter GDP growth to come in at 5.4 per cent!

That really spooked the stock market since 4th quarter GDP was only 2.6 percent which was below consensus estimates of 3 percent. The Friday’s job numbers fueled the downdraft even further as investors digested a stronger-than-expected jobs report where the average hourly wages rose more than expect.

Higher wages can point to higher inflation, which, in turn, could lead the Fed to raise interest rates more aggressively. Those concerns allowed the 10-year Treasury yield to rise above 2.8 percent.

Keep in mind that the S&P 500 has risen 6 percent in the year to date and is on track for its 10th straight month of gains. At these levels, this would be the best January since 1997. The S&P’s relative strength index ended last week at 90, its highest level on record. (Overbought territory) Its price-to-earnings ratio hit 18.44 times forward earnings this week, its highest level since May 2002.

Two other factors that may have contributed to the main benchmarks suffering their biggest one-day drops in more than a year and posting the steepest weekly losses in about two years.

  1. Friday marked the last day for Janet Yellen as the head of the Federal Reserve, giving way to her successor, 64-year-old Jerome Powell. Powell’s entry adds uncertainty into the markets.
  2. The politics in D.C. with the release of the Nunes memo adds political uncertainty as to whether the business friendly republicans will lose in the November elections.

The Dow Jones futures market points to a negative opening on Monday. There could be even more selling pressure near the end of the week because of a possible government shut down over Trump’s immigration demands.

Why you shouldn’t worry

  • The Atlanta Fed was also optimistic about the 2017 first quarter, estimating growth at one point to be 3.4 percent, where the final reading came in at 1.2 percent.
  • Higher wages doesn’t always lead to higher inflation. Consumers could opt not to spend but pay down debt or increase their savings.
  • Over the long run, good quality stocks will outperform bonds.

In my thirty plus years of investing, I have seen many bear markets and corrections. Ask yourself a simple question. How many millionaires do you know that became wealthy by investing in savings accounts?

What is on my shopping list? U.S. financials and technology.