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Earning Potential of an Investment

The point of investing is to make money on your money. Judging the earning potential of an investment is basic to making this work. This is the case for both long term investors who buy and hold for years and for stock traders who attempt to time the market in search of short term profits. The earning potential of any investment depends on appreciation in value, realized earnings in the short term (dividends), and the value of the currency in which the investment is denominated. The last factor is affected by inflation and the volatility of the Forex market.

Judging the Earning Potential of an Investment

Your investment time horizon is a major factor in how you judge the earning potential of an investment. Stock traders use technical analysis tools to read the sentiment of the stock market but also use market sentiment data from other sources. This is because they are only concerned with how the price of a stock will perform in the near term when they decide to buy, sell, or trade options. On the other hand, long term investors look for intrinsic value. This is potential of an investment to make money over the long term. Using tools like the CAPE ratio a long term investor will purchase a stock during a market downturn because the company has long term potential that is not reflected by the current price.

Profit Potential in Business and Long Term Investing

Investopedia discusses whether profit or growth is more important for a business.

To be successful and remain in business, both profitability and growth are important and necessary for a company to survive and remain attractive to investors and analysts. Profitability is, of course, critical to a company’s existence, but growth is crucial to long-term survival.

Profit in terms of money in the bank is important for keeping a business afloat during good times and bad. But, without assets being plowed back into R&D, expansion, and new products, a company will not grow. The goal of a long term investor is to choose investments that have both qualities namely a margin of safety in terms of cash and potential for steady growth over the years.

Market Timing and Profit

The market loves a stock that shows increases in its quarterly earnings. Thus, quarterly profits are a major driver for short term stock prices. The key to making this work for short term investors and traders is to correctly anticipate quarterly earnings in comparison to estimates. The stock price going into the release of financial a report will have determined the prevailing stock price. That price will jump up or fall down based upon the released earnings.

How Long Will Profits Last?

Warren Buffett was famous for avoiding tech stocks until he became a huge investor in Apple. His concern was always that companies whose profits were based on advanced technology could not guarantee that their proprietary technology would stay in the forefront. He finally invested in Apple because he believed that Apple had a strong brand name and following. This puts it into the same category as Coca Cola and some of Buffett’s other favorites. These stocks tend to be good long term investments. When looking at the earning potential of an investment, investors are wise to follow Buffett’s lead and beware of investments that depend on a momentary lead in technology or companies without a strong brand name and following.

Another concern for offshore investors is the value of the currency in which a stock is denominated. The stock may go way up but if the currency takes a nose dive, that does not help. Sticking with ADRs is a useful way to avoid this problem as American Depositary Receipts are priced in US dollars.

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How to Make Safe Investments

In the midst of a global pandemic, the stock market crashed and then recovered to reach record highs. This has happened despite a grim economic picture. The disconnect between the market and the economy has many investors worried about how to make safe investments going forward. What are the safest investments today? Are there any safe investments with high returns? Are there any safe investments for seniors? And, what are some quick return investments for those willing to jump into and out of the market? What is the safest way to invest money today?

Safest Way to Invest Money

The safest way to invest money is to put it in a bank account in the USA. The Federal Deposit Insurance Corporation insures each and every account up to $100,000. This applies to checking and savings accounts as well as certificates of deposit. The next best choice for safety is to purchases US Treasuries. They are backed by the US Government. In each case, you are accepting low interest rates in return for safety of your investment capital. If you are looking for AAA corporate bonds, Johnson & Johnson and Microsoft are rated AAA. These are not insured but safe investments.

Safe Investments for Seniors

The best investment advice for seniors is to rotate out of risky, growth investments as retirement nears. This means moving into value stocks, bonds, CDs, and US Treasuries. You are giving up the chance for faster gains but ensuring that your investment capital does not disappear during a market crash just when you need it to survive. The chief worry with this approach in an era of extremely low interest rates is that you will outlive your savings. Thus, many experts suggest that you keep part of your portfolio in value dividend stocks with the possibility of continued growth over the years. You can take the dividends as income or use a dividend reinvestment plan to keep growing that part of your portfolio.

How to Make Safe Investments
How to Make Save Investments

Quick Return Investments

If you are looking for a quick return on your investments, you are trying to time the market. This rarely works over the long term but there are times when quick returns are possible. One of these happened early in 2020 when the Covid-19 pandemic caused the stock market to crash. Using the CAPE ratio as a guide, investors could see that the crash had taken value stocks down too far considering their long term value. This is the essence of intrinsic value investing, discovering stocks that have long term potential that outshines their current market prices. This approach can be very profitable over the long term or provide good short term profits as well. However, the conditions need to be exactly right for it to work in your favor.

Investment Calculator

If you want to know how much an investment will return, you can use an investment calculator such as the one at investor.gov. This tool helps you by calculating compound interest or appreciation for predictable investments. It can be applied to long term CDS, a savings account, US Treasuries, AA and AAA bonds, and dividend stocks that have stood the test of time. It is of no worth if you are investing in penny stocks during a pump and dump scheme in which you are led to believe that last year’s 20% gain will be repeated every year into the distant future.

Safe Investments with High Returns

The safest investments rarely offer high returns. But, dividend stocks that have paid dividends for decades or even more than a century are safe and often provide growth opportunities. Despite the use of the terms growth stock and value stock, these are not exclusive categories. Over the long term value stocks as a group tend to outperform growth stocks as a group. This is because so many growth stocks fizzle out or only provide short term growth.

Choosing Your Investment Wisely

Apply what you know in life and in business to your investments. Peter Lynch who ran Magellan Fund decades ago gave a good example. In the late 1970s a popular investment was to buy and lease railway boxcars. When this was done correctly the investor could depreciate the value of the boxcar and gain income as well. This sort of investment was sold to professionals like doctors who made lots of money but had little time to study investments. The problem with the investment was that too many investors never found anyone to lease their boxcars.

During the same time, the drug Tagamet (Cimetidine) was discovered. This acid-blocker absolutely changed how doctors treated stomach and duodenal ulcers. The drug sold like hotcakes and Smith, Kline & French stock went up like a rocket. But, doctors who saw this happening in their professional lives were still buying boxcars and losing money while not buying stock where their expertise should have given them insight.

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Your Investments and the Weakening Dollar

The dollar has fallen by an eighth against a basket of currencies since its high point in March. How will a weakening dollar affect your investments? The last point of comparison was in 2017. Why is the dollar falling? Will the current trend continue? And, how should you position your investment portfolio to account for a weakening dollar?

Why Is the Dollar Falling?

The dollar is a safe haven currency for people all over the world. When times are difficult, investment tends to flow into the USA and strengthen the dollar. Now that vaccines are expected to help stop the pandemic global optimism is on the rise and this strengthens investment options other than the USA.
In addition, the US Federal Reserve has promised to go “all in” on keeping interest rates low, buying bonds, and printing money to keep credit flowing and the economy from going into free fall. The prospect of interest rates being low for the long term weakens the dollar. And, the Biden administration will most-likely push for more financial support across the board and for low interest rates into the long term future. Investors looking for high returns will end up looking to Europe or Asia for investment opportunities.

Will the Weakening of the Dollar Continue?

A hallmark of the Trump administration has been the trade war with China and high tariffs. This has tended to strengthen the dollar. Because Biden is more likely to rely on other means of dealing with China, consumers will be paying less for imported products, global growth will be positive and the dollar will continue to fall.

As we have frequently noted, a weak dollar is not a bad thing for American industry and tends to support exports. Thus the dollar will fall until it hits a level where it helps American industry and then it will stabilize. Meanwhile the price of oil will be cheaper in foreign currencies as will other commodities that are routinely denominated in dollars.

Because not all nations prefer a surge in their currency versus the dollar we can expect central banks to take action, which will modify the picture.

Because the pandemic is the root cause for effects on the global economy and currencies, we can expect all of this to continue for months as the disease worsens in the winter months, vaccines take months to be administered in sufficient quantity and people are convinced to abide by common sense precautions to drive down the incidence of Covid-19.

How Should You Invest with a Weakening Dollar?

The US economy is going to worsen before getting better. The longer Congress waits before passing more broad-based stimulus measures the worse it will be. To avoid having your investments hurt by a weakening dollar look offshore. You can purchase ETFs that track offshore stocks or bonds. You can increase your investments in US multinationals that have huge offshore footprints. And, you can move savings into foreign currencies or purchase commodities that will benefit from a falling dollar. For most folks, US multinationals or ETFs in the USA that track foreign stocks are easier to invest in and get out of and don’t require you to learn Forex or commodity trading!

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What Is the CAPE Ratio?

The CAPE ratio averages out the P/E ratio over a ten year period. This acts like important moving averages to reduce the influence of fluctuations in the economy and the market. CAPE is an acronym for cyclically-adjusted P/E ratio and was made popular by Robert Schiller, an economics professor at Yale University. We recently wrote about the dangers of a high P/E ratio. Using the CAPE instead of the standard P/E ratio reduces this risk. While the P/E ratio shows stock price divided by earnings per share the CAPE averages out the stock price and earnings over a decade. This measure is more commonly applied to market indices like the S&P 500, NASDAQ, or Dow Jones industrial average than to individual stocks. As such it is a useful indicator of an over-priced or underpriced market.

CAPE Ratio Formula and What It Tells You

Here is how to calculate the CAPE ratio.

CAPE Ratio = (Share price ten year average adjusted for inflation)
divided by ten-year inflation-adjusted earnings

This approach is useful for long term investors who use intrinsic stock value as a guide. The CAPE ratio for individual stocks gives you a better picture than the immediate P/E ratio of how good an investment will be over time.

Although Professor Shiller has popularized the CAPE in recent years, it was first suggested by Benjamin Graham and David Dodd in the 1930s in their book, Security Analysis. Shiller and John Campbell used the approach in the run up to the dot com crash and accurately predicted how badly the market would fall due to its being overpriced in the late 1990s.

The limitation of the CAPE, like the P/E ratio is that it is backward-looking and does not take into account new technology or trends.

CAPE Ratio 2021

Will the CAPE ratio be useful as we move into 2021 with the pandemic peaking and the economy tanking? The value of the CAPE ratio is that its value at any given time is closely correlated with the prospects of a security over the following 20 years. Thus, it may not give a lot of insight into if and when there will be a market crash in 2021 or a raging bull market. But, it does tell us what to expect from any given sector, stock, or market over the coming years. Since long term investing depends on holding stocks for seven to ten years or more, the CAPE is useful for long term planning. If you believe that stocks are hugely overpriced in relation to the current CAPE ratio you may be able to predict a correction or crash but not the exact timing.

NASDAQ Cape Ratio

Over the last few years the CAPE ratio for the NASDAQ 100 has consistently come in higher than the P/E ratio. P/E ratios the tech giants in NASDAQ have been high over the last few years. This indicates the potential for corrections. The higher-still CAPE ratios indicate the potential for long-term corrections. This would most-likely happen as interest rates rise, society comes out of the Covid-19 pandemic, and work-from-home becomes an option instead of a necessity.

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Biden Bull Market Investments

The new president takes charge on January 20, 2021. We expect to see the stock market respond with a rally for value stocks and those connected to infrastructure investments. A split Congress will likely delay any tax increases and interest rates are likely to remain low for a long time. The pandemic will subside with multiple vaccines available and the economy will improve which will drive value stocks higher, perhaps at the expense of tech stocks that have benefited from stay-at-home work.

Low Interest Rates

Low interest rates have been a major driver for the stock market. Bonds and bank CDs offer little return on investment capital making stocks the only investments that offer decent returns. Until the economy has recovered, which may take years, interest rates are likely to remain low and keep driving money into the stock market. Negative interest rates would only do so more rapidly.

Infrastructure Investing

The sorry state of American infrastructure needs to be addressed and likely will be by the upcoming administration. This is likely to be largely a “Buy American” effort that will stimulate the economy, provide needed jobs, and spread prosperity throughout the country. Although roads, bridges, airports, and ports are commonly noted to need uplifts, advanced technical efforts like upgrading to 5G will also benefit.

No Tax Increases

The disparity between the rates normal people pay in taxes and what the super-wealthy pay has been in public discussion for some time. However, to raise corporate taxes and plug loopholes for the super-rich, the Democrats need to control both houses of congress. Right now they are two short of a 50-50 tie. Because Vice President Harris can vote to break a tie, the Democrats need to take both senate seats that are in run-off elections in Georgia. Although they may flip one of them, taking both seems like a long shot. As such we expect the Republicans to keep control of the Senate and block any efforts at increased taxes on your investments.

Biden Bull Market Investments- Charging Bulls
Running of the Bulls, Pamploma

The Pandemic Will Subside

As painful as the Covid-19 pandemic has been and as burdensome it has been on the economy, it will subside. There are three vaccines (and counting) ready for review and possible initiation of vaccinations by the end of December 2020. Producing workable vaccines in less than a year has been barely short of magic considering that the process typically takes a decade or more. Everyone does not need to get vaccinated. If the number of folks who get vaccines plus the folks who have been ill and have recovered gets to the 70% range, the pandemic will begin to subside. This will allow life to start returning to normal. That won’t require any laws to be passed to political arm-twisting. Money will start to flow and value stocks, especially, will benefit.

Democrats Tend to be Better for the Stock Market

The stock market has tended to do better when a Democrat is in the White House and so does the economy. This is generally because there is more money being spent and spread around. We don’t expect the Biden administration to be any different. For some thoughts about potential Biden bull market investments, take a look at what The Motley Fool writes about stocks to look at for a Biden bull market.

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Cryptocurrency Investment Regulation

Those who purchased cryptocurrencies like bitcoin when they were a few dollars each have become rich. And, those who purchased bitcoin at the end of the 2019 pump and dump lost their shirts as the cryptocurrency fell from nearly $2000 each to the $600 range. Now that the pandemic has raised havoc in the economies of the world, bitcoin and other cryptocurrencies are soaring again. Cryptocurrencies are a concern to governments around the world because one can buy and sell, transfer assets, and never been seen. Terrorists and the drug trade are believed to benefit from the hidden nature of cryptocurrency trading. While many would like Bitcoin and other cryptocurrencies to move into the mainstream, regulation will be necessary to protect investors and reduce the attractiveness of cryptocurrencies to those who want to hide money.

Cryptocurrency Investment Regulation

A major issue for cryptocurrency investment regulation is how to trade bitcoin and others. Are they securities, commodities, or currencies? The Library of Congress Law site provides insight into how cryptocurrencies are treated, avoided, regulated, or ignored around the world.

One of the most common actions identified across the surveyed jurisdictions is government-issued notices about the pitfalls of investing in the cryptocurrency markets.  Such warnings, mostly issued by central banks, are largely designed to educate the citizenry about the difference between actual currencies, which are issued and guaranteed by the state, and cryptocurrencies, which are not.  Most government warnings note the added risk resulting from the high volatility associated with cryptocurrencies and the fact that many of the organizations that facilitate such transactions are unregulated.  Most also note that citizens who invest in cryptocurrencies do so at their own personal risk and that no legal recourse is available to them in the event of loss.

Before cryptocurrencies are accepted into the financial mainstream, they need to be regulated. The report summarizes how this has been done in 130 nations across the world.

Cryptocurrency Investment Regulation

Cryptocurrencies as Securities, Commodities, or Currency

Who regulates a cryptocurrency and how they do so depends on what you consider this type of asset to be. Lexology.com looks at this issue. In the EU central banks have noted that cryptocurrencies do not fit the legal definition of a currency as they are digital representations of value and not issued by central banks or other like institutions. However, the European Court of Justice said that for tax purposes they should be treated as currencies.

Because securities are tangible proof of ownership of debt, the Chairman of the US SEC said that cryptocurrencies do not qualify as they don’t represent ownership.

In regard to cryptocurrencies as commodities, regulators have noted that cryptocurrencies do not represent anything of underlying value such as with coffee, gold, or natural gas. Nevertheless, the US Commodity Futures Trading Commission said in 2018 that in certain instances cryptocurrencies are commodities. In fact, you can trade Bitcoin futures on the Chicago Mercantile Exchange.

Because this issue is still up in the air, two nations have moved to qualify cryptocurrencies as Digital Ledger Assets (DLTs). They have both enacted laws regulating cryptocurrencies within their jurisdictions using this definition.

Cryptocurrency Sales and Taxation

Although the USA does not yet have a strict definition of what a cryptocurrency is for regulatory purposes, the IRS has made it clear that profits from selling bitcoin and other cryptocurrencies are taxable either as short term or long term profits, depending on how long you have held them before selling.

Regulation and the Future of Cryptocurrencies

The general consensus of experts is that regulation will have a dampening effect on the wide swings in monetary value of cryptocurrencies. It will probably have a beneficial effect on the safety of holding cryptocurrencies as exchanges will likely need to open their books to regulators and have better guarantees that assets to not disappear overnight with a couple of computer keystrokes!

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US Isolationism and Your Investments

The South China Morning Post reported the signing of the Regional Comprehensive Economic Partnership that includes China and most of its Asian neighbors. This deal includes Japan, Australia, New Zealand, and South Korea but not the USA. The new trade deal will lower tariffs and aims to increase regional trade with less red tape. Post-pandemic growth is expected to benefit in the region. Not only is the USA not part of this deal but it is also not part of the Transpacific Partnership which the Obama administration helped develop and Trump pulled out of. Here are some thoughts about US isolationism and your investments.

Protectionism and Your Investments

Protectionism, according to Investopedia, is when a government restricts international trade. The goal of protectionism is typically to stimulate economic activity in the county. However, it can also be instituted for reasons of safety, quality, and geopolitical concerns. As with the trade war started by Donald Trump, tariffs and import quotas are common tools. The infamous Smoot-Hawley Tariff Act in the 1930s was meant to protect US industry but initiated a trade war that was partly responsible for the depth and length of the Great Depression. Protectionism is often driven by a desire for isolationism. A country and its people feel threatened by foreign competition. The Trump trade war played on a belief that foreigners were taking advantage of the USA and that the USA had to close its borders to trade or hike up tariffs to protect itself. The result so far appears to be an exclusion of the USA from two important markets at a time when China and other Asian markets are expanding. How should you invest when US companies will find it more difficult to compete in a third of the economies of the world?

Investing from an Isolated Country

If you want to invest where there is more economic activity, you may need to invest abroad instead of in the USA. This means investing in foreign stocks. But, if laws like the Kennedy Act take hold, investing in China will be more and more difficult. The targeted decoupling from China will become a greater and greater issue going forward. However, you can invest in companies that do business in other nations in the Asian Pacific. These companies will likely benefit from trade deals from which the USA is currently excluded. ETF Trends writes about investments from abroad. As they note, the USA is about 25% of the world market and that percentage may well decline as other economies advance and the US stagnates in isolationism. Luckily, you do not need to speak a foreign language or deal with a stock broker in a foreign country in order to invest in foreign markets. You can choose investment funds that track offshore investments and you can purchase ADRs (American Depositary Receipts) of foreign stocks listed in US stock exchanges.

A good resource for checking out ADRs is the website TopForeignStocks.com. The ADR listings are grouped according to economic region and then by country. US News has a nice listing of ETFs with an international focus, low costs, diversified, and meant for safe long term investing.

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Covid-19 Pandemic and Surge in ESG Investing

Many expected ESG investing to take a dive due to the economic stresses of the Covid-19 pandemic but there has been a surge of ESG investing instead. It appears that long term investors realized that the best-run companies were the most likely to endure and prosper during these difficult times. And, the stresses of the pandemic have also reinforced concerns about how we deal with our planet and each other.

Covid-19 Pandemic and Surge in ESG Investing

Financial News published an insightful piece in regard to the Covid-19 pandemic and surge in ESG investing. As they note, the strongest focus has been on the “S” in ESG in that human capital management and labor standards. Well-run companies with a focus on sustainability are the most likely to survive and prosper.

The trend of Environmental, Social and Governance investing, or ESG, has been gaining momentum for years as climate change and other social ills threaten to alter the capitalist landscape. Then the virus struck. Many assumed the ESG focus would fade. But early on in the crisis, major shareholders urged company bosses to focus on employee well-being and on ensuring that suppliers were paid during global lockdowns, even if this meant cutting or suspending dividend payments.

This attention to how a company acts going forward is likely to continue to focus on governance and sustainability as well as environmental concerns according to JPMorgan Asset Management. They state, according to Financial News, that nearly three-fourths of their investors believed that the Covid-19 crisis will lead to more concerns about issues like biodiversity losses and climate change. It would seem that the pandemic has made us realize that the natural world has a huge say in how human life and investments play out!

The number of investment funds focusing on ESG investing has multiplied and these funds are making it clear to companies that they will put their investments with those who emphasize an ESG focus more than a focus on short term profits.

Covid-19 Pandemic and Surge in ESG Investing
Courtesy Lixoretf

Demand for ESG Investments Increases Due to the Covid-19 Pandemic

Morningstar also notes that investors are demanding ESG investments during the pandemic and for afterward. Investment trusts and ETFs are maintaining an active focus on the companies they are invested in and active stewardship as well. Thus they meet with corporate boards to review ESG issues. The first issues right now have to do with employee health, safety, and retention. But, supply chain issues are of great concern both for company viability but also concerns about forced labor, employee mistreatment, and dealings with military and spy services as with China. While the US government is moving toward decoupling from China for national security reasons, ESG investors are concerned about company viability and the effects of the work force.

With the increasing focus on the safety of our natural world, ESG investing is looking to the long term with investments in socially and environmentally responsible projects that will help us avoid Covid-19-like disasters in the future.

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Decoupling of Investment in China

As the Covid-19 pandemic began, the USA had to go begging China to send protective masks made in China (by 3M). American had become dependent on a global supply chain to the extent that it had become a risk to national security. This situation had been decades in the making and the USA and other nations are taking actions. Decoupling of investment in China is a major part of this movement.

Decoupling of Investment in China

Although the decoupling of investment in China hit the general news as the pandemic was playing out, it has been on the minds of many for quite some time. In January of 2020 The Harvard Business Review wrote about how the USA and China will decouple.

While Covid-19 has dominated news for much of the year – and understandably so, as people and businesses fight for their survival – a larger, longer-lasting problem has been unfolding in the background, which many businesses will soon need to contend with: As de-globalization accelerates, two hostile economic blocs are emerging, one centered around China and the other around the United States.

Arguably, we’ve been headed towards this moment for a long while. De-globalization has been under way for more than a decade: At best, international trade was stagnating before the pandemic hit, and foreign direct investment had fallen by 70 percent in 2018 from its peak in 2007. Never easy, Sino-U.S. relations have taken a more confrontational turn under Xi Jinping. By 2018 we were already witnessing the opening skirmishes of a new Cold War.

We wrote about the Kennedy Act and investing in China a few months ago. In that article we noted how China has been using US investment capital to build up its high tech sector and how that sector often works hand in hand with Chinese intelligence operations and its military. The USA and other nations have been helping fund the rise of a nation bent on dominating Asia and then the world. We cannot stop them from having such ambitions but the USA, Europe, and others do not have to fund those efforts.

How Will Decoupling from China Affect Your Investments?

In the Harvard Business Review article they suggest several measures for international companies to take.

Reduce Business Presence in Hong Kong
Relocate Supply Chains to Politically Safer Countries
Reassess relationships with Chinese businesses and universities
Consider the geopolitical risks and reposition accordingly

As a US investor, you may be barred from certain investments in China and the number of prohibited investments may increase over time. Your decoupling of investment in China should be led by the degree of involvement of that investment with Chinese military or intelligence operations.

Direct US Actions to Decouple from China

The New York Times reports that investment in companies with military ties has now been barred by presidential action in the waning days of the Trump administration. Specifically, this means investments in Huawei, China Mobile and China Telecom. The list includes 31 companies including China Mobile Communications Group, China Telecommunications Corporation, Huawei, Sinochem Group, Hangzhou Hikvision Digital Technology, China Railway Construction Corporation, Inspur Group and Aviation Industry Corporation of China.

The order takes effect on January 11, 2021 and if you have investments in any of these companies or funds that invest in them, you have until November 11, 2021 to divest yourself of those assets. It is of note that China Telecom fell $4 a share from $36 to $32 on the news. However, the stock is now selling for what it has been worth for most of the year during the Covid-19 pandemic and resulting economic slump. This was a long time coming and is not likely to be reversed by the Biden administration. As such, investors need to get out of the specific investments on the list and consider what else might be pulled into the decoupling of the USA and China as a new cold war begins.

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