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Saving With Negative Real Interest Rates

As historically low interest rates persist and inflation accelerates, saving with negative real interest rates becomes increasingly futile. In this article we take a look at real interest rates and how to save and invest in the current era. We have written about how negative interest rates can affect your investments. For now rates are not likely to go negative but also the Fed appears to be in no great hurry to raise rates despite inflationary pressures. Thus, many are confronted with the problem of saving with negative real interest rates for the foreseeable future.

What Are Real Interest Rates?

The return as measured in purchasing power that an investor receives for an interest rate investment (bank savings, US Treasuries, bonds) is the real interest rate. Simplistically, this is the rate of a savings account, CD, Treasury, or bond minus the rate of inflation. In an article about how now is a terrible time for savers, The New York Times notes that savers have two choices. One is to keep their money safe with interest rate investments like CDs and Treasuries and accept that they will be losing purchasing power on those investments. And, two is to continue to invest in stocks with the potential for a greater return on investment along with the risk of the stock market correcting or crashing with substantially greater losses.

Saving With Negative Real Interest Rates
Real Interest Rates for Inflation-Adjusted Bond

What Is Your Rate of Inflation?

The rate of inflation that you experience will depend on what you need to buy. If you are in the market for a new home, prices are up 15% year on year since 2020 and if you need to buy lumber for an addition to your home, expect to pay 400% more than last year for the same materials. Used cars are up as are new cars as chip shortages have cut back on new car production. But, if you own your home and expect to drive your car for years, you are better off. Costs of health care, insurance, and medicines are rising at a rate faster than the reported 2+ percent of inflation. If you are employed in a growing business sector you can expect to see your wages go up to compensate for inflation. If you are retired, you can expect to need to count your pennies more and more over the years.

What Can You Do About Negative Real Interest Rates?

According to Investopedia inflation eats away at your retirement. Despite yearly inflation, the government does not always increase Social Security payments every year and when they do they use an index that is more appropriate for younger people and not old folks for whom things like health care are major parts of their budget. Standard advice for those going into retirement has always been to rotate more and more of your portfolio into interest bearing vehicle such as bonds, CDs, and Treasuries. The rationale has always been that retirees cannot afford the risks associated with all of their wealth being tied up in stocks. However, today it would appear that retirees cannot afford to see their wealth being eaten up by the corrosive effects of negative real interest rates.

Stable dividend stocks, utilities especially, have traditionally been part of retiree portfolios. Today, the safest way to invest in the stock market is probably to use dollar cost averaging and invest in an ETF that tracks the S&P 500. The SPY which tracks the S&P 500 passes through the dividends that are paid out by the stocks it invests in. The current rate is 1.26% per year. The point is to retain a steady cash flow along with appreciation in value to your portfolio in an attempt to stay ahead of inflation and avoid just saving with negative real interest rates.

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Lithium Mining Investment Issues

As the world moves steadily towards electric vehicles and efficient means of storing energy with batteries, lithium batteries have become a major player. Lithium batteries are rechargeable repeatedly, light weight, and can store large amounts of electric energy. They are used in car batteries and that use is expected to go up to ten times the current use by 2030 while GM, Volkswagen, Tesla, and others bring more and more electric vehicles into service. While the USA has abundant sources of lithium only one lithium mine exists in the USA producing about 2% of current production. Lithium mining investment issues will become increasingly important as the USA moves to both mine more lithium and manufacture lithium batteries domestically for domestic use.

Domestic Lithium Battery Supply Chain

Currently, two-thirds of the world’s lithium batteries are made in China. As the USA found out in the early stages of the Covid-19 pandemic, disruption of supply chains for foreign-made products can lead to manufacturing halts, loss of business, and other painful results. As the USA and China increasingly compete to dominate the global economy, the USA is moving to develop supply chains for products like lithium batteries that will not be at risk due to trade disputes or power play supply cutoffs. In short, mining lithium and producing lithium batteries in the USA has become a national security issue closely tied to the health of the American economy.

Problems with Mining Lithium in the USA

The New York Times wrote about the lithium gold rush to power electric vehicles. While lithium batteries are part of the answer for a greener future, lithium is a mixed blessing when it comes to mining it and the other minerals, like cobalt, needed to make lithium batteries. One of the projects they write about is a proposed lithium mine project in Nevada called Lithium Americas that has drawn criticism.

But the project, known as Lithium Americas, has drawn protests from members of a Native American tribe, ranchers and environmental groups because it is expected to use billions of gallons of precious ground water, potentially contaminating some of it for 300 years, while leaving behind a giant mound of waste.

It turns out that while the USA has lots of lithium reserves, traditional mining of these reserves can have very “non-green” side effects when the point of using lithium batteries for cars and energy storage is to create a “greener” world. From an investor’s viewpoint, national security concerns will probably overshadow many of the environmental concerns for many projects. However, not all sources of lithium and not all ways of extracting lithium are as problematic as the Lithium Americas project.

Lithium Mining Investment Issues - Open Pit Mines

Extracting Lithium from Brine

Lithium is found in brine deposits and this is where much of the lithium “mined” in South America comes from. A new process that holds promise for extracting lithium more efficiently and economically may also hold promise for investors. Lilac Solutions has developed ion exchange beads that can be used to more-efficiently extract lithium from salt brines without the many polluting issues related to traditional lithium mining.

Lithium Mining Investment Issues - Ion Exchange Extraction

A site where investors plan to try this approach is the Salton Sea in Southern California. The sea sits atop an extinct volcano and the plan is to build geothermal power plants that by them themselves will generate income and pay for the extraction process of taking lithium from the hot water from 4,000 feet below the surface as is passes through the power plant. Because salt brines contain large amounts of lithium, this approach may be a more commercially and environmentally feasible way to extract large amounts of lithium than traditional mining.

While Lilac Solutions is a privately owned company they don’t do the mining. They produce the means for ion exchange lithium extraction from brine. We suggest that while the stampede begins to mine lithium and build battery production facilities in the USA that investors consider lithium mining investment issues such as those associated with traditional mining when choosing where to invest their money for a greater profit with fewer problems.

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Investing With Synthetic Stock

When we talk about synthetic stock we are really talking about stock options. Synthetic stock is a way to establish a long position in a stock with substantially less investment capital than if you want to buy the stock outright. Synthetic stock also carries risk. “Buying” synthetic stock is done by purchasing calls on the stock in question and then selling puts on the same stock in order to reduce the cost of the calls. The cost of this approach is less than buying calls and greatly less than buying the stock. The risk of investing with synthetic stock lies in the possibility that the stock will fall in price.

Understanding Calls and Puts in Options Trading

If you are interested in investing with synthetic stock you need to start by understanding calls and puts in options trading.

What Is a Call?

A call is an option contract in which the buyer gains the right to purchase a stock at the price stated in the contract, known as the strike price. He or she can do this at any time during the duration of the contract for an American style option and at the end of the contract for a European style option. The seller of the call contract earns a premium but takes on the obligation of selling the stock at the strike price if the buyer exercises the contract. With a long-term options contract such as a LEAPs option that can run three years the buyer may simply choose to leave the contract open as the stock price goes up.

What Is a Put?

A put is an option contract in which the buyer gains the right to sell a stock at the price stated in the contract, the strike price. For American style options this can be at any time during the duration of the contract and for European style options at the end of the contract. The seller earns a premium for which he or she takes on the obligation of selling the stock at the strike price even when the stock has fallen significantly in price, creating a substantial loss.

Basically you buy a call or sell a put when you think a stock will go up in price and you sell a call or buy a put when you think that the stock will fall in price.

Using Call Options to Invest

Because we are talking about investing with synthetic stock, we are talking about using call options to invest. A good example for investing with synthetic stock is The stock has had a great run and the company has dominant positions in all of its business sectors. As such it would seem to be a great long term investment. One of the problems is that stock sells for more than three thousand dollars a share, $3,292 as we write this. However, one can purchase call options on for substantially less than what it costs to buy the stock. How much less depends on the strike price that you choose. Calls that are substantially “out of the money” because they are priced much higher than the price of today can be purchased for pennies a share.

What Happens When You Buy Synthetic Shares?

In order to make money using call options to invest, you need to buy enough options and hold them long enough for the strategy to gain a reasonable profit. LEAPs call options can be contracts that run up to three years. However, you are tying up your money for three years too. To further reduce your investment you can also sell put options. This is what happens when you buy synthetic shares. You are buying call options in expectation of a profit and selling put options to reduce the cost of the investment. Provided that the stock, like goes up in price over the next couple of years you will gain a profit similar to what you could have gained by buying the shares but you will have done so for a greatly reduced price.

Is Investing With Synthetic Stock Safe?

Options trading can help investors leverage their investment capital which is what happens when investing with synthetic stock. But, some options strategies carry a risk. Selling puts to allow you to buy more call options and control more shares also puts you at risk of loss if the stock falls unexpectedly in value. If we look at where was five years ago at $772 a share and where it is today $3,392 a share, we can see how well a synthetic stock strategy can work for some who gets in before a nice rise in a stock price.

Investing With Synthetic Stock - Amazon 5 Years Last Five Years

But, if we look at just this last year, when started at $3,191 a share and has peaked at $3,531, $3,443, $3,471, and $3,719 only to land back at $3,292 today, we can see the risk of investing with synthetic stock. This investment strategy offers a way to leverage a small amount of investment capital into huge profits but comes with the potential for huge risk.

Investing With Synthetic Stock - Amazon 1 Year Last Year

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How SPY Investing Works

Since the depths of the Financial Crisis the S&P 500 has gone up from 825 to 4441 today. Because of how well the S&P 500 has done over the years, many investors have chosen to invest in this index rather than choose individual stocks. Since you cannot buy shares of the S&P 500 index, what can you do? The choice that many investors make is to buy shares of the SPDR S&P 500 Trust ETF or SPY, an ETF that tracks the S&P 500. How SPY investing works is just like buying individual stocks except that you are investing in the 500 largest publicly traded US companies.

What Is the SPY?

The SPDR S&P 500 Trust ETF or SPY is a popular way to trade the Standard & Poor’s 500 stock index. Because of the breadth of its constituents, the S&P 500 is considered a benchmark of the US economy. When one invests in the SPY they do not have any individual stock-specific investment risks. Rather, the S&P 500 and therefore the SPY is driven by factors that drive the entire economy. Because the SPY is an ETF in which you can buy and sell shares, the “overhead” is less than with something like a mutual fund or paying someone to manage your investments. Commonly investors use dollar cost averaging to add to their SPY investments.

Is It Good to Invest in SPY?

Many investors do not have the time or the expertise to successfully pick and track stocks to invest in. And, the S&P 500 and therefore the SPY have beaten many managed investment services over the last few years. The overhead is low. Because you do not need to do a lot of research before investing in SPY you are saving time. Because the S&P 500 keeps going up, you are making money by investing in SPY. So, is it good to invest in SPY? Yes, it is. In fact, Warren Buffett suggested that most investors would be more successful with this sort of approach because they do not have the time or expertise to successfully pick stocks and time purchases.

How SPY Investing Works

What Is the Minimum Investment for SPY?

Because the SPY lets you buy fractional shares, you can invest as little as $1 in SPY. The fractional share aspect is good when you use dollar cost averaging because you do not need to calculate just how many shares to buy every pay period, month, or quarter. As of August 10, 2021, the SPY goes for $442 a share. This price in dollars is about a tenth of the S&P 500 index which is 4432 at the same time that SPY trades at $442. When you buy shares or fractional shares of SPY you also pay fees and commissions but you do not pay management fees like with a Mutual Fund or managed account.

How Do You Invest in SPY?

As with all stock investing you need to go through a stock broker. You can do this online with someone like TD Ameritrade, Fidelity, Charles Schwab, Interactive Brokers, or E*TRADE. Simply set up a brokerage account and add money to the account. If you want an investment that tracks the S&P 500 you will be able to choose between various mutual funds and ETFs. If your choice is the SPY, simply choose that and make your investment.

Is the S&P 500 a Good Investment?

A good investment should be one that makes money, has limited or no risk, does not cost a lot to maintain, and falls within your time and ability to manage it. An investment that tracks the S&P 500 and especially the SPY win on all points. You may choose to limit your investing to the SPY or you may use the SPY as a proxy for the S&P 500 for the “conservative” part of your portfolio. In either case an investment vehicle that tracks the S&P 500 is a good idea for most investors.

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The VIX as a Guide to Your Investing

The VIX or so-called “fear index” is an indicator of near-term stock market volatility. Using the VIX as a guide to your investing can keep your portfolio out of trouble and result in profits. Since this indicator focuses on the options market 23 to 37 days hence, it is a better tool for guiding short and medium term investing more so than the long term. Never-the-less, long term investors commonly step into the market to pick up bargains during downturns which makes the VIX a useful tool in alerting these investors as to when a correction will be coming.

What Is the VIX?

The VIX or fear index is the CBOE Volatility Index. It was created by the Chicago Board Options Exchange and shows options market expectations in real time. It assesses near-term expiration (23-37 days out) options for the SPX index which in turn tracks the S&P 500. It indicates apprehension in the wider market and gives a heads up for coming market volatility, either up or down. The VIX doesn’t say which way the market is going. It just indicates volatility in the coming days.

VIX Calculation

The VIX is arrived at daily by a complex calculation. It uses SPX put and call options that expire 23 to 37 days out and generates a volatility measurement for the next 30 days. Using options prices to determine volatility is one of two means of measuring volatility. The VIX looks at prices of calls and puts within the time frame measured and uses that information to tell us what the options market expects. The calculation is complex and has been updated from its original form. By checking a range of strike prices of the dates sampled it provides a real-time measure of expected volatility.

Volatility and Your Investments

The stock market corrects by 10% or more about every two years on the average. Stock market crashes of 20% or more happen every decade or more often, on the average as well. Meanwhile, the market and individual stock bounce up and down as market sentiment drives them. Market volatility may mean investment risk but also can lead to significant profits. Long-term investors watch stocks during volatile markets and compare market prices with projected prices based on intrinsic stock value. They pick up underpriced stocks that have been dragged down by market panic and enjoy the fruits of their investing for decades as these solid stocks continue to grow and produce solid cash flow. The bottom line is that you can use the VIX to spot volatility and then scout for bargains.

The VIX as a Guide to Your Investing

What is a Normal VIX?

First of all, market volatility comes and goes, so a “normal” VIX simply is any number that reflects current market expectations. An “average” VIX in an average market runs between 12 and 22. A VIX less than 12 is seen in a very quiet market and any VIX above 23 goes with increasing volatility. It is important to realize that the VIX is, to a degree, self-correcting. The market looks volatile. Options traders hedge their bets and the VIX goes up. Investors and traders adjust their tactics based on the expectation of increased volatility and thus volatility generally goes down. This is, in fact, “normal” VIX behavior.

Can You Buy the VIX?

The VIX is an index just like the S&P 500 whose call and put options it tracks to make its calculations. As such you cannot buy or trade the VIX directly. But, just like you can buy or trade the SPX which tracks the S&P 500, you can buy shares of ETFs and ETNs that track the VIX. But, while you could buy and hold shares of any of these ETFS or ETNs, you very likely do not want to, EVER! These instruments are useful for short term traders in stocks, futures, and options. Because the VIX goes up and down, so do these ETFs and ETNs. There are highly experienced traders who “buy” and “sell” volatility in terms of these instruments on a daily basis in search of short term profits. This is not the place for a long term, buy and hold investor to be.

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Extreme Weather and Your Investments

The forest fires in the American and Canadian West as well as historic flooding in Western Europe, China, and India have brought us to consider the relationship between extreme weather and your investments. In this case, we are not talking about the planet warming but about repeated local destructive climatic effects of that warming. As an example of an extreme weather event, we chose a 1941 blizzard that paralyzed the upper Midwest long before climate change or extreme weather events were ever thought of.

Economically Destructive Extreme Weather Event Caused by El Niño – 1941

On November 11, 1941 the Armistice Day Blizzard hit the upper Midwest. Temperatures fell from above average to below freezing, a foot of snow blanketed a region hundreds of miles North by South. 150 people died as well as thousands of livestock. In this era when no one had ever heard of climate change it was an El Niño year. Beside there being storms along the Pacific Coast of the Americas, more energy was imparted to storms into the midsection of North America.

Extreme Weather and Your Investments
1941 Armistice Day Blizzard

The point of this example is that a warmer climate is likely to generate more extreme weather events.

Economic Effects of Extreme Weather Events as Opposed to Global Warming

Global temperatures are rising according to long term measurements. Does this affect your investing? For example, the argument that higher temperatures will cause more droughts is countered by the arguments that more Northern and Southern regions will be available for growing crops and that higher CO2 levels will have a “fertilizer effect” that will increase food production.

The extreme weather that we are seeing is likely an effect of “more energy” in the atmosphere and as temperatures rise is likely to continue. Thinking about extreme weather and your investments is not such a bad idea if you want to protect your investments. Here are some of the many local risks associated with extreme weather events.

Where Are the Extreme Weather Risks?

Sea coast cities come to mind as we are seeing stronger and more frequent hurricanes with powerful tidal surges. Add these events to gradually rising sea levels and property investments in coastal cities become risky. Of the ten largest cities in the world, eight are coastal.

  • Tokyo, Japan (coastal)
  • Mexico City, Mexico
  • Mumbai, India (coastal)
  • Sáo Paulo, Brazil
  • New York City, USA (coastal)
  • Shanghai, China (coastal)
  • Lagos, Nigeria (coastal)
  • Los Angeles, USA (coastal)
  • Calcutta, India (coastal)
  • Buenos Aires, Argentina (coastal)

Insurance Risks of Extreme Weather

In 2005 hurricane Katrina hit the US Gulf Coast and generated insurance claims totaling $41.1 billion across six states. It was the largest total loss in the history of the insurance industry. July 2021 German floods have caused an estimated $8 billion in claims. California wildfires in 2020 caused $6 billion in losses. As extreme weather events become more common, so will insurance losses.

Local Agricultural Losses Due to Extreme Weather Events

While global agricultural production of crops such as wheat, corn, and soybeans will typically not vary a great deal year to year, yields in specific areas are susceptible to droughts, floods, and severe storms.

Extreme Weather and Your Investments - Flooded Crops
Flooded Cropland in the UK

As the climate warms, extreme weather events will become more common endangering local investments but not necessarily the entire agricultural sector. Large agricultural companies are diversified across food sectors and geographical areas giving them protection from extreme weather losses.

Local Extreme Weather Risks for Tourism and Construction Industries

Like agriculture, these industries are scattered across the globe. While extreme weather may be devastating in one area it will not affect others. As such investing in a hotel chain like Marriott would be safer than investing in a single hotel in one city. Likewise, investing in a construction conglomerate would be safer than in a single local construction company.

Extreme Weather and Electric Power Companies

When a recent cold snap froze Texas, natural gas pipelines froze and electric power lines were both put out of action. Businesses shut down and people burned furniture to keep from freezing. Electric utilities that do not prepare for extreme weather conditions will increasingly become investment risks. The choice that many of these companies face is to risk problems down the line or spend money now to prepare and reduce their dividends for a time.

Safe Investments as Extreme Weather Events Become More Common

Our belief is that despite a fair amount of recurring chaos associated with global warming and extreme weather events society and the economy will adapt. Setting up business right on the shoreline in a coastal city and only in that location could be risky. Avoiding investments in hurricane, flood, and forest fire-prone areas would seem to be a better idea. Companies that have assets scattered across the country or the globe will be less likely to be devastated by singular events and companies like Apple, Microsoft, Amazon, and the rest that have assets on the internet are likely to avoid any single devastating weather event. Likewise, investments in ETFs that track whole sectors or the entire S&P 500 should be decent ways to avoid having your wealth destroyed by one blizzard, dry summer, flood, or other extreme weather event.

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Worst Investing Mistakes

As more and more folks were forced to sit at home during the height of the pandemic, more and more took up online trading and investing. Unfortunately, along with more investors, we have seen more and more investing mistakes from the likes of naïve, new Robinhood investors. The sorts of mistakes made by many of these new investors are not new to the investment world. As such, we present our list of worst investing mistakes to help our readers from falling prey to habits that ruin otherwise successful investing.

Delaying the Start of Investing

The US stock market has been a money making machine for more than a century. Although some investors hit home runs with lucky stock choices the majority of investors make money a bit at a time over many years. Like putting money in the bank to gain interest, putting money in the stock market provides returns over the years. The difference is that stocks rise and fall on their way up and provide a better rate of return over the years than money in the bank. The exponential growth provided by stocks provides a higher rate of return and more rewards the longer you stay invested. Thus, delaying the start of investing is generally a mistake.

Investing Money You Will Need Right Away

Investing is meant to build a rainy day fund, money for retirement, or capital for investing in your own business. It is not meant to be invested and immediately taken out. In fact, it is absolutely possible to invest in an excellent stock and see it fall briefly because of conditions in the larger market. When you start investing, make sure to keep enough cash in the bank to cover expenses for three to six months so that you are not forced to sell a temporarily depressed stock at a loss due to a short term emergency.

Investing without Clear Goals

Why are you investing? What do you expect from your investments and how soon? How much risk are you willing to take while investing? Investors need to be able to answer these questions before they start putting money into the stock market either for individual stocks or into an ETF. Your investment choices will generally flow quite normally from your goals and without goals you will commonly not be successful to the same degree.

Following Bad Social Media Investment Tips

Tips can lead you to great stock investments or totally lead you astray when investing. As we have repeatedly written over the years, investors need to check out any tips before committing any money. Successful investors never put money into a stock until they understand how the company makes money and how that income stream will continue over the years. If your investments are going to be short term, you need to learn how to track market sentiment with market sentiment data. And, for longer term investing you need to understand and use tools like the CAPE ratio.

Worst Investing Mistakes

Chasing Market Trends

Chasing market trends can be worse than following tips. Stocks and the general market go up and down. New investors commonly jump in toward the end of a bull market, paying too much for overpriced stocks. The market falls and they wait until it is ready to bottom out before selling, thus losing most of their investment capital. Then, they stay away from the market until they are enticed in again by a bull market. Choose good stocks based on sound analysis and use dollar cost averaging to avoid chasing market trends.

Watching the Markets Constantly

Successful investors keep track of their investments. But, they do not constantly obsess over the market or individual stocks. Excellent stocks like Apple, Microsoft, and have gone up very nicely over the last decade and more. But, they have all fallen in price both with the larger economy and from simply day to day, week to week, and month to month fluctuations. If you worried about every time Microsoft lost a percent or so and sold your stock you would have lost out on an eight-fold increase in value not to mention routine dividend payments over the last ten years.

Not Investing with a Long Enough Investment Horizon

Someone once asked Warren Buffett what was his favorite holding period for a stock and he answered, “forever.” Successful investors like Buffet only invest when they understand how a company makes money and ideally how the company will continue to execute a successful business plan for the next decades or even century. Well-chosen stocks will perform well over the years but may have months or even a year or two when they are down. So long as you understand their fundamentals, you can generally trust them as long term investments and stick with them. Unsuccessful investors all too often dump good stocks because their time horizon is faulty.

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Covid Persistence and Your Investments

As vaccines are administered to more and more people, the rates of Covid-19 have fallen across the USA, Canada, the UK, and continental Europe. China is slow with its vaccinations but strict control measures have helped considerably in the nation where Covid-19 started. However, new Covid-19 variants are causing spikes in cases in nations like India, South Africa, and much of South Asia and Africa as well as South America. Economic growth is expected to go as high as 6.8% in the USA and even higher in China. However, this optimism is largely based on the expectation of Covid-19 being controlled and going away. Covid-19 recovery on a global scale and even within largely-immunized nations may not come as fast as we had hoped. Thus our concern has to do with Covid persistence and your investments.

Herd Immunity Threshold and Your Investments

Vaccines do two things. They protect the person who is vaccinated from getting a disease or from getting a severe case of it. And, when enough people are vaccinated or have already had the disease, this halts the spread of contagious diseases. Thus, childhood vaccinations for measles, mumps, and chickenpox have been given for years to provide personal protection and have driven down the rates of these “childhood diseases” to the vanishing point, except in areas where vaccine hesitancy has caused parents to not get their kids vaccinated.

With Covid-19, you get protection from the virus which is important for older people and others who are at greater risk and who are more likely to get very sick, be hospitalized, or die. For the sake of the public, the economy, and your investments the hope is to get to herd immunity. The “enough people” percentage for Covid-19 has been pegged at 70% of the population based on the initial spread of the virus. However, the new delta variant is more contagious. As a reference point, the Mayo Clinic notes that the herd immunity threshold for measles (a very contagious disease) is 94%!

You get variants arising from a disease like Covid-19 when lots of people remain susceptible to the disease. As such, vaccine hesitancy in the USA, Canada, the UK, and continental Europe may be setting up for more and more aggressive strains of Covid where the herd immunity threshold may rise to 80%, 90%, or higher!

Thus, one needs to be concerned about how vaccine hesitancy affects your investments.

Covid Persistence and Your Investments - Herd Immunity

Economic Growth as Covid is Controlled

The numbers look good for a post-Covid recovery providing that there is not a huge resurgence. The World Bank predicts a strong but uneven recovery based on steady increases in vaccinations and making vaccines available across the nations of the world. The USA is expected to grow at 6.8% this year and China at 8.5%. However, global growth is likely to be 3.2% lower than predicted prior to the pandemic with many nations having shrinking economies. The longer term concern is that many nations have run out of cash and are running out of credit which has led to widespread demonstrations and even violence in countries like Colombia and South Africa. Skills sets have been diminished as workers have been sidelined and students have been unable to go to school. Never-the-less, things will improve everywhere, including with your investments, providing that vaccinations proceed and herd immunity is reached.

Economic Slowdown as Covid Persists

The fly in the ointment regarding any rosy predictions of strong economic recovery is the rise of new Covid-19 strains like the delta variant. Infectious disease experts have estimated that the herd immunity for the delta strain is likely closer to 85% than 70%. Thus, as more and more people refuse vaccination in the USA, UK, and continental Europe, we risk persistence of Covid-19 or even the worst case scenario of a repeat of last year if new strains are resistant to natural immunity from the initial strain and from vaccines. If that happens, all bets on a strong recovery will be off.

Where to Invest as Covid-19 Persists

Pretty much everyone’s economic and investment projections have assumed that eventually Covid-19 will either burn itself out by having infected virtually everyone or that enough vaccine will have been put in enough arms to reach herd immunity. If this goal is not achieved or Covid-19 gets worse again, where do you invest? All of the investments in high tech that allowed businesses to continue during the lockdowns will probably do well and continue to grow. Hospitality, travel, and other sectors that were driven down during the height of the pandemic will likely be hurt. Biden’s infrastructure-related investments will likely prosper. And, companies that make Covid-19 vaccines and will make both boosters and “re-tooled” vaccines for new variants will turn into long-term investment opportunities as the world copes with Covid-19 for years to come.

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Predictors of Stock Performance

When you invest in the American stock market, you are looking to make a profit, build up savings for retirement, avoid loss, and grow your wealth. Whether you are investing in individual stocks or an ETF that tracks the market, two values are important. What can you buy a stock for today and what will it be worth at a future date. Since the current stock or ETF price is readily available, what you need are predictors of stock performance going into the medium to distant future.

How Do You Predict if a Stock Will Go Up?

In regard to stock price performance, the first thing we have is past price action. Stocks and the market follow trends. So, trend following can work, at least for a while, in predicting that a stock will keep going up or keep going down. Unfortunately, stocks correct and crash when they have gone too high either due to internal factors in the company or problems in the overall economy. And, when stocks start to fall they usually don’t fall forever. Many successful long term investors pick up bargains by purchasing stocks at the bottom of a trough. How can they do this?

Intrinsic Stock Value Is One of Best Predictors of Stock Performance

While market sentiment data can be an excellent guide to short term price changes, accurate prediction of longer term stock prices comes from accurate predictions of future earnings. Intrinsic stock value is a predictor of the forward looking earnings of a company. It was first suggested in the days after the 1929 stock market crash and beginning days of the Great Depression. Benjamin Graham suggested this approach as an alternative to “playing the market.” Most famously, his protégé, Warren Buffet has used this approach for decades on the way to becoming one the richest people in the world.

Formula for Calculating Intrinsic Stock Value

Here is the formula that Graham provided in 1962.

  • V = EPS x (8.5 + 2g)
  • V is the intrinsic stock value
  • EPS is the trailing 12 months earnings per share
  • 8.5 was the P/E ratio at the time for a “zero-growth” stock
  • g is the company’s long term rate of growth

The solution to the formula, (V), is compared to the current market price of a stock. When V is less than one, the stock is overpriced and when (V) is more than one, it is underpriced. Nobody suggests that an investor blindly apply this formula but rather learn what a company does to earn money and how that plan will continue to work into the future. Then, using intrinsic value as a guide, long term investors can get out of overpriced stocks in the last days of a bull market and pick up bargains as a bear market bottoms out. The key to this approach is to be able to pick companies able to make money for decades instead of just for months or years.

Predictors of Stock Performance - Intrinsic Value
Intrinsic Value versus Current Stock Price over Time

P/E Ratio versus CAPE Ratio as Predictors of Stock Performance

A similar approach for assessing the value of a stock is to look at the price to earnings ratio (P/E ratio) when compared to other stocks in its market niche. The CAPE ratio is a variation of this approach what seeks to average out the P/E ratio over a decade. CAPE is an acronym for cyclically-adjusted P/E ratio and it acts like a long term moving average indicator by averaging out fluctuations in the P/E ratio over a decade.

Value Investing for Long Term Investment Success

The US stock market is a long-term money-making machine. However, to reliably profit one needs to stay invested for five to ten years after picking sound investments with tools like the P/E ratio, CAPE ratio, or intrinsic value calculation. The conclusion of successful long term investors like Buffett is that it is too difficult for the average investor to time the market with individual stocks and that buying shares of an ETF that tracks the S&P 500 is a better idea. Using a dollar cost averaging approach the investor avoids buying too much at high prices and buys for shares at low prices thus mimicking the intrinsic value approach.

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Chairman Mao and Investing in China

We recently wrote about the political dangers of investment in China from the perspective of especially large tech companies that are being forced to follow the Chinese Communist Party line or be subjected to humiliation and worse. But not only could investments in China run afoul of the powers on high but also from discontented youth across the length and breadth of China. The New York Times writes about the words of Mao Zedong who asked “Who Are Our Enemies?” Chairman Mao is seeing a resurgence of popularity among the disaffected youth of China.

Long Hours and Low Pay for Chinese Workers

The picture that many in the West see regarding China is of shining new construction in huge cities, increasingly powerful businesses, and more and more aggressive foreign policy under the current leader, Mr. Xi. But, a closer look reveals tired and angry youth who hate their long hours at work (9am to 9pm), low pay and lack of affordable housing. These young people have taken to reading and quoting the first Communist leader of China, Chairman Mao. We suggest that investors pay attention to what is going on as Chairman Mao and investing in China are going to be related.

Angry Chinese Youth Question What They Are Getting from the Government

As noted in The Times, Mao’s call for violence and struggle is ringing true for disheartened young Chinese workers. The focus of this resurgence is not the chaos visited in China by its first Communist leader when millions died due to poor decision making and attempts to maintain power. Rather, it is that Mao’s works help justify the anger that these people feel about their situations as “struggling nobodies.” Workers view the prosperous business class in China much as 19th and early 20th century workers viewed rich capitalists in Europe and North America with similar calls for violence if things do not change.

Chairman Mao and Investing in China
The Little Red Book of Mao’s Sayings

The Consent of the Governed

Political philosophy says that governments are only legitimate and justified in using the power of the state if they govern by the consent of the people. This happens in democracies by free elections. When it happens in authoritarian countries like Communist China it is because the government is giving people much of what they want even though the people have no say in who runs the country or how. In China the Communist Party has kept people happy by creating a system in which there has been lots of employment and the ability to create wealth in their system of “managed capitalism.” The Party claimed credit for all success and tells the people they should be grateful. That sounds increasingly hollow to those working the traditional 9 am to 9 pm six day a week job in China with no prospect of moving out of such a trap.

As economic growth slows the ability of the Party to bribe its citizens with “things” is less than it used to be. With no labor protections, housing the young people cannot afford, and draconian work schedules the current Chairman, Mr. Xi, is turning to nationalism and tighter controls with finger pointing at tech companies which is the first political danger of investment in China that we wrote about.

But, as Mao found out, riling up the people and trying to use them as a weapon against your enemies can backfire or at least have unexpected consequences. The one that the Party fears the most is a general uprising against a non-elected government.

Chairman Mao and Investing in China - Mao's Chaos Could Visit China Again
Mao Used His Sayings to Exert Control Through Chaos

Chairman Mao and Investment in China

It would not take an all-out civil war to create havoc in China’s economy and cause damage of investments in China. The rise of a true “people’s movement” is what the Party fears and while they were able to take over Hong Kong and eradicate remaining liberties by portraying youth there as traitors to the mainland, the same approach will not work within mainland China. Back in the late 19th century in Europe and North America workers became so angry that there were bombings of government offices and assassinations. Move forward to China of today and you have just one more reason to follow the ABC (anywhere but China) approach to your investing.

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