After a horrible beginning, stocks rebounded off their lows late last week. They appear to headed lower again today, and the month of August will end up being a definite loser for stock investors.
Still, count me in as an unwavering long term optimist, as the real investment gains are measured in years and decades rather than days, weeks or months.
Many market pundits are saying that it's time for a big market 'correction,' aka fall, as stock prices are greatly overvalued at current prices. My crystal ball disagrees, and I definitely can envision prices headed substantially higher over the next several years.
That said, I certainly don't know, nor is it even knowable, where share prices are headed in the short term. And anybody who claims to have such knowledge about the short term direction of the market is wrong. Yet they keep trying. See Some Stock-Market Experts Still Bracing For More Trouble.
Here's what I think. Long term oriented investors can anticipate with some reasonably high level of confidence that total returns (price appreciation plus dividends) will grow by ~50% from today's levels in the next five years.
And the reasons for this admittedly optimistic assessment are simple: (1) interest rates and inflation rates will remain low even after the Fed raises them from their current basement level, and (2) the American economy will continue to strengthen, as will the sales and earnings of well run companies. With that simple set of assumptions in mind, let's explore why it's realistic to expect that share prices are headed higher the next several years.
First, realizable gains in stock prices over the long haul are a result of share price growth from (1) actual increases in earnings, (2) valuation due to a price to earnings (PE) multiple expansion, and (3) cash dividends. Another critical ingredient is the comparison of the 'earnings yield' on stocks to the expected interest rates on bonds (fixed income yields). We'll look at the earnings yield factor today.
When valuing stock prices on a fundamental basis, a good checkpoint is to compare the current and expected ten year U.S. treasury bond yield plus the estimated inflation rate to the 'earnings yield' on stocks. So let's see what that simple analysis reveals about the outlook for stock prices.
U.S. Blue Chips With Fat Dividends Offer Value is Barron's cover story this week. It has this to say about the attractiveness of blue chip companies' stock prices today because of the 'earnings yield' of these high yielding dividend paying blue chip stocks in a low interest rate environment: "While stocks, as measured by the S&P 500, aren’t cheap by historical standards at a current 16 times forward earnings, they aren’t expensive, either. The earnings yield, the inverse of the price/earnings ratio, is 6%, or more than 2.5 times the yield on the 10-year Treasury bond."
Using the S&P 500 as a proxy for the market as a whole, stocks are priced at 1,989. Estimated earnings for the S&P 500 for next year are ~$120. 1,989 divided by 120 equals 16.
The current PE (price to earnings) multiple for the index is therefore 16. Here's another way of looking at the same thing: the earnings yield, aka the reciprocal of the PE multiple, is 6%. (120 divided by 1,989 equals ~6%.
Now let's compare that to the current bond yield of 2.18% for ten year government bonds.
2.18% is much lower than 6%, so that implies that stock prices aren't overvalued today. It also implies that if the Federal Reserve is successful at getting inflation up to 2% from its current ~1% level, then the estimated future government bond yield would be 4% ( 2% targeted inflation + 1% to 2% real return on government bonds = 3% to 4%, so we'll assume 4% for comparison purposes.).
A 4% interest rate is one third lower than the current earnings yield of 6%. On that measure alone, stocks remain attractively priced today. In fact, if the S&P 500 index were to climb to 2,400, or 20% higher than its current price, and S&P index earnings reach ~$120 next year as anticipated, then the earnings yield would decrease to 5%, but still a favorable indicator for higher share prices.
Thus, I'm not going to worry about prices being too high as long as I believe that interest rates will stay low. And thanks to energy prices and a strong U.S. dollar, it's reasonable to expect inflation to stay around 2% for some considerable time to come.
In other words, for the foreseeable future interest rates on ten year treasuries will be lower than historically has been the case due to continuing low inflation and low commodity prices attributable to a strong dollar and a weakened China.
To repeat, we arrive at a fair value PE of 20 by using 5% as the new 'normal.' Of course, using a less conservative 4% would indicate a fair value PE of as high as 25.
Accordingly, S&P 500 earnings of $120 point to a fair value of between 2,400 and 3,000. Today we sit at ~2,000.
In addition, higher earnings over time will increase the earnings number from $120 to perhaps $160 within five years. This valuation adder will more than offset unforeseen modestly higher future interest rates and still get us to that 3,000 neighborhood, despite an unexpected increase in interest rates.
And that's why I don't believe the market is overvalued today. To the contrary, my view is that it still has 'miles to go before it sleeps.'
So while I'm not predicting a moon shot, neither am I expecting a substantial fall in share prices over time. And I do expect PE multiples to stay higher than 'normal' instead of contracting in this forecasted low inflation and low interest rate environment for the next several years.
Meanwhile, increasing cash dividends on blue chip stocks will keep on coming and grow consistently over that time as sales and earnings increase. But here's the closer: even if I'm wrong, I'm a long term individual investor who is in it for the long haul. That means I won't be scared out and unduly troubled when encountering the inevitable volatile trading periods during the next several weeks, months and years.
There is a distinct tendency for too many of today's Americans to prefer socialism and embrace greater government control in the pursuit of fairness and under the misguided goal of broad based income equality.
That march toward socialism, assuming it continues unabated, necessarily will result in a society discarding the inherent benefits associated with an educated citizenry, self reliance, individual freedoms, self determination and overall societal prosperity.
Of course, today's big government advocates and supporters are working diligently to encourage the widespread belief that income inequality is unfair and that only 'selfless' leaders like Hillary Clinton (government) and Jonathan Gruber (academia) who have acquired great wealth by 'serving' We the People, aka Sheeple, are capable of teaching us how to right these perceived 'wrongs.'
They fail to mention that in a free, fair and prosperous society, income inequality is a good, natural and inevitable outcome --- as is widespread knowledge about how things really work.
Nobel prize winner Milton Friedman said this: "A society that puts equality before freedom will get neither. A society that puts freedom before equality will get a high degree of both."
Today's lessons coming from China and the United States clearly and unmistakably prove Friedman's point.
"Miao Leijie loses money on each ton of cement his company produces. . . .
Changzhi and its environs are littered with half-dead cement factories and silent, mothballed plants, an eerie backdrop to the struggling Chinese economy.
Like many industrial cities across China, Changzhi, which expanded aggressively during the country’s long investment boom, has too many factories and too little demand. That excess capacity, many economists indicate, will have to be eliminated for the Chinese economy to return to healthy growth.
But rather than shut down, Lucheng Zhuoyue and other Changzhi companies are limping along in a kind of march of the undead.
To protect jobs and plants, the government and its state-owned banks sometimes keep money-losing businesses on life support by rolling over or restructuring loans, providing fresh credit or offering other aid. While this may seem like an odd business tactic, it is part of a broader strategy to help maintain social stability, a major goal of China’s leadership. . . .
Similar strategies have been tried before, with little success. In Japan, such businesses, known as “zombie companies,” are blamed for contributing to that country’s two decades of economic stagnation.
As China allows its own “zombies” to stalk the economy, the situation is clouding the country’s outlook, making it difficult to predict where growth is headed. If the leadership doesn’t address the underlying problem, the economic weakness could be prolonged.
Concerns have already been rising that China’s slowdown is worsening and its problems are becoming harder to overcome. . . .
Far from the sparkle of Shanghai or the export zones of Shenzhen, Changzhi is a modest city of three million people who live in low-rise apartment complexes and work in boxy factory compounds. The local economy depends on steel manufacturing and other heavy industries that girded the country’s decades-long era of high growth. As the property market grew and the government plowed money into roads and other infrastructure, cement factories sprouted on the city’s outskirts to capitalize on the bonanza, creating hundreds of well-paying jobs. . . .
Empty apartments built during the boom are now weighing down the property sector. Businessmen in Changzhi complain that construction projects supported by the local government have also been scaled back.
As a result, Changzhi’s cement plants are saddled by excess capacity. Companies in the province can produce three times as much cement as what was actually needed in 2014 . . . .
Such conditions have turned once promising companies into zombies. While trucks are still parked outside the sprawling industrial compound of Changzhi’s Huatai Cement Clinker Company, there are far fewer than just a couple of years ago, and they have less to haul. The money-losing company has produced a mere 200,000 metric tons of cement this year, even though it is able to make one million.
As a state-owned enterprise, Huatai has been kept running with the help of special assistance. Huatai gets coal on credit and access to cheap loans from its parent company, which is owned by the provincial government. That has allowed management to keep all its 300 workers on the payroll — the company’s top priority. “Our employees need to eat, they need to live,” said one manager, who declined to give his name.
Such measures may help sustain employment, but they also delay the much needed overhaul of Chinese industry. A study of China’s labor market by the International Monetary Fund released in July noted that state-owned enterprises tended to keep workers that they did not need. From an economic perspective, it would be better for such businesses to downsize or even close, releasing their trained staff to work at companies or in sectors with stronger prospects. That would shift resources away from less productive parts of the economy, helping get growth back on track.
Without such a shift, the economy could suffer in the future. Raphael Lam, deputy resident representative at the I.M.F. in Beijing, says Chinese policy makers should move more forcefully to enact pro-market reforms and allow state-owned enterprises to restructure. If not, he says, “Over the long term, there would be an increasing likelihood of a sharper slowdown.”. . .
The situation is also complicating matters for workers not lucky enough to keep their jobs. Though unemployment has remained low nationally, workers in troubled Changzhi complain that good jobs are hard to find.
At the Changzhi Cement Group, where the only sound is a barking dog, a former company electrician, Zhao Liwei, 43, watches TV inside a decrepit room for janitors at the compound’s entrance. Two years ago, as production at the state-owned plant ground to a halt, her paychecks stopped coming. Most employees were left to fend for themselves.
Ms. Zhao has not worked at all. The only jobs in the area, she says, are sweeping floors and waiting tables, for as little as 500 renminbi, or $78, a month. She earned twice that working at the factory. “We were promised an iron rice bowl” — the Chinese term for lifetime employment — she said. But now “it is like we’ve been left on an eternal, unpaid vacation.”Some of these idled workers have faced biting hardship. Sitting outside a nearby deteriorating residential complex, Du Jianping, 45, says that she has to rely on handouts from her parents to put food on the table for her 12-year-old daughter. She and her husband lost their jobs at the Changzhi Cement Group, and ever since, Ms. Du has been earning a pittance selling women’s clothes and children’s toys at a stall outside a train station.
She feels trapped, fearing she would be unable to get better work elsewhere. “We are too old to find jobs in the cities,” she said. “I hope the government could help lift up the cement industry so that it can recover.”
Beijing is sensitive to such pleas. Fearing that joblessness could lead to social instability, the government has made maintaining employment a primary goal of its economic policy. Premier Li Keqiang said during a news conference last year that the lowest growth rate acceptable to the regime “needs to ensure fairly full employment and realize reasonable increase of people’s income.”
That helps explain why Beijing is taking stronger action to prop up the economy. . . .
Still, such steps may do little more than keep zombie companies alive — to the detriment of the overall economy. By pumping up growth with fresh credit and stimulus, the government might temporarily revive some factories, but also exacerbate the economy’s problems of excess capacity and high debt.
The consulting firm IHS Global Insight estimates that debt relative to China’s output will reach 254 percent in 2015, nearly double the level of 2008. Such debt levels can pose substantial risks to an economy if borrowers are unable to repay them and a wave of defaults follows. “The size of debt only accumulates,” said Grace Wu, a senior director at the rating agency Fitch in Hong Kong. “That doesn’t help with the underlying economy. It doesn’t help create jobs.”
Over the long term, Chinese policy makers are trying to decrease the economy’s dependence on excessive investment for growth and allow household consumption to play a bigger role. That means the factories in many heavy industries, like cement, may never run again at full tilt." ..........................................................................................
America is a different story. We have a relatively free market society and economy where free choice driven consumer spending accounts for two thirds of the nation's economic activity.
"Consumer spending rose in July as American households stepped up vehicle purchases, but consumer sentiment dipped in August. Though confidence remains at levels consistent with solid spending growth, many households have been fretting over a recent stock market sell-off. . . .
Economists say that underlying strength — also highlighted by a rebound in business spending, and buoyant housing and labor markets — gives the economy muscle to weather the fallout from the market rout.
The economy grew at a 3.7 percent annual rate in the second quarter, according to revised data released on Thursday. The consumer spending data was the latest report indicating momentum in the economy as it confronted global market turbulence, sparked by concerns over a slowing Chinese economy . . . .
Consumer spending should be supported by steady income growth and higher savings. Last month, personal income increased 0.4 percent in July. Income has risen by that same percentage for four straight months. . . .
“The economy has built up a huge amount of steam to push it forward in the months to come with the substantial cash reserves that consumers are holding,” said Chris Rupkey, chief financial economist at MUFG Union Bank in New York."
Summing Up
China's socialist and elitist government controlled chickens are coming home to roost.
In the end, Chinese citizens, aka the Sheeple, will pay the price for all this government provided 'protection,' as the citizens of an elitist government run society always and inevitably do.
On the other hand, America's still relatively free market oriented chickens are beginning to lay lots of edible eggs for U.S. consumers, aka We the People.
Yet I wonder why many of my fellow Americans choose not to see what is easily seeable.
Could the explanation be as simple as what journalist Edmund R. Morrow once said, "The obscure we see eventually. The completely obvious, it seems, takes longer." It seems so.
After a hectic and extremely volatile week in the stock market, prices ended higher. Of course, all the market turmoil caused much angst among both professional pundits and individual investors. And because it very well may continue in the coming weeks and months, now's a great time to pause and reflect on what is going to be the best path going forward for long term oriented individual investors.
So let's turn to some simple but sage advice from a long term successful investor and adviser, Burt Malkiel, to see what he has to teach about the folly of short term trading moves and attempts to 'time the market.'
The conclusion is simple --- market timing trading doesn't work to your advantage. In fact, it invariably works against you. I say he's right about that.
Market Timing Is Dangerous by Burt Malkiel offers this time tested and experience based advice to individual investors:
"I think one of the cardinal rules of investing is don’t try to time the market. And the reason is that you’ll never get it right. I’ve been around this business for 50 years and I’ve never known anyone who could time the market and I’ve never known anyone who knows anyone who could time the market. You can’t do it. It’s very dangerous.
And in fact, what makes it particularly dangerous is it’s not simply that you don’t know how to do it. It’s that when you do it, your emotions get behind you and you’re more likely to get it wrong than right.
What we know people do is they tend to put money into the stock market when everyone’s optimistic. And when everyone is pessimistic, they tend to take money out of the stock market. More money went into the stock market in the first quarter of 2000, which was the top of the Internet bubble, than ever before. And what it went into was into Internet stocks and into funds that bought Internet stocks.
And then the money came out in 2002 and early 2003, that was at the bottom of the market, exactly when it shouldn’t have come out. And then in the third quarter of 2008, during the height of the financial crisis, more money came out of equities than ever before. People were taking money out by droves. And that was exactly when they should have been putting money in.
And so when people try to do it, we have abundant evidence that it’s not simply that they get it wrong randomly. They do exactly the wrong thing. Don’t try to time the market. Nothing could be more dangerous. You’ll never get it right and you’re more likely to get it wrong than right."
Summing Up
Mr. Malkiel is absolutely right about the foolishness involved with short term market timing trading. Catching a falling knife is both difficult and dangerous. And always selling when prices are going lower and buying when prices are going higher makes no sense either.
So let's act smart by setting aside such foolish thoughts and resolve to be boring but successful long term savers and investors.
And by so doing, we'll let the 'smarter than we are' foolish folks out there engage in all the daily trading.
By so doing, they will also 'earn' the long term losses associated with that short term oriented methodology. The rest of us 'dummies' will take the long term gains.
I've long been of the view that politics sucks. And sadly, that thought gets stronger with each passing day of today's silly political debating and name calling season.
But today let's take a specific peak at the ongoing politics inspired disaster occurring in Wisconsin. It's a specific story that teaches why We the 'Sheeple' is an apt description of the Jonathan Gruber type disdain that most American politicians and government officials have for We the People.
If you are unfamiliar with the Wisconsin story, it goes back several years and involved a widespread and not-so-secret government run conspiracy and attempt by Wisconsin 'progressives' to defeat Scott Walker as Governor. By so doing, they would thereby maintain the public sector union leadership's influence and control over state affairs and keep in place the state's reckless spending of taxpayer, aka 'Sheeple,' supplied money.
Fortunately, the effort failed, but it clearly reveals a story that needs to be understood by We the People, lest Gruberism prevails and we become a nation of 'Sheeple.'
We 'the Sheeple' is subtitled 'New evidence that partisanship drove John Doe' and updates the sad and sick story which continues to unfold in Wisconsin:
"Wisconsin’s Supreme Court shut down the John Doe investigation of conservative groups in July, but it turns out the probe was even worse than the judges knew. Documents . . . show that partisan motives ran through those who conducted their operations in secret while using gag orders to silence targets.
Wisconsin’s Government Accountability Board (GAB) regulates elections. . . . GAB staff, including Director Kevin Kennedy, worked with . . . the Milwaukee Democratic District Attorney’s office to subpoena and intimidate the major conservative players in Wisconsin politics. The investigation coalesced around the controversy over Governor Scott Walker’s union reforms and pushed the liberal agenda to limit political speech. . . .
GAB staff counsel Shane Falk encouraged the special prosecutor to keep up the good work and “stay strong” in his pursuit of conservative nonprofit groups and allies of Mr. Walker. . . .
“The cynic in me says the sheeple would still follow the propaganda even if they knew,” Mr. Falk continued . . . . By “the sheeple” Mr. Falk means Wisconsin voters.
In June 2014, Mr. Schmitz’s attorney, Randall Crocker, issued a statement saying that Governor Walker was not a target of the investigation into campaign finance coordination. “You just lied to the press,” Mr. Falk wrote in an email to . . . Mr. Kennedy, others at the GAB and Milwaukee DA John Chisholm. . . .
The Doe team was also apparently concerned that exonerating Mr. Walker as a target might have an effect on the election or damage the chances of 2014 Democratic nominee for Governor Mary Burke....
Was Mr. Falk reprimanded for his obviously partisan motives? Apparently not. When Mr. Falk left the GAB last year, Mr. Kennedy sang his praises in a departure memo posted on the GAB’s website, saying he “exemplifies all that is great about the people who work at the Government Accountability Board” and that his contributions “have been critical to steering us through some extraordinarily challenging times.” . . .
We also know that GAB staff counsel Nathan Judnic marched against Mr. Walker’s Act 10 reforms and wrote on Twitter that the state should “Stand in solidarity. Kill the bill. Support public employees and their right to bargain.”
Mr. Kennedy says the GAB is a nonpartisan agency, but the GAB was an active partner in the Doe, and there was nothing nonpartisan about that."
Summing Up
In Wisconsin and elsewhere, it's Government by SOME of the people, for SOME of the people, and of SOME of the people.
Or should we say 'SHEEPLE?'
Well, that's our call to make and not that of the Jonathan Grubers of the political world. They merely want our money to spend as they please while continuing to treat us with disdain and disrespect.
1- Market Update .... Stock markets are in rally mode, and today looks like we could see the second in a row of a solid recovery for U.S. stocks. The Dow rose 600+ points yesterday, and today looks like we could see another triple digit gain. China even had a good day as its market climbed more than 5%. European markets are showing huge gains as well.
My market view remains that prices are undervalued and that the strong U.S. dollar, low commodity prices, low import prices, low inflation, a growing U.S. economy and low interest rates all combine to make for a solid long term investing environment for individuals.
In future postings, we'll explore this 'room to grow' thesis in more detail, but for now suffice it to say that sustained low interest rates should result in an overall improvement in 'price to earnings' (PE) multiples, thereby raising share prices.
Currently the market PE is ~17 and my expectation is that it can increase to 20 or higher. If I'm right, that means stock prices are more than 15% lower than they should be based on the more realistic and higher expected market PE.
The basis for this belief is my view that future interest rates will remain much lower than their historical averages due to the many positive effects of the aforementioned strong dollar, low inflation and a growing U.S. economy. Interest rates will rise from their present historically low base over time, of course, but not by much.
CAVEAT ... All that said, nobody knows the future. That's why it's called the future, and it hasn't happened yet. But that's the way I see things. In any event, as a long term individual investor in stocks, it doesn't change my approach even if I'm wrong about the expanding PE scenario.}
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2 - Now let's talk about Donald Trump and why he's wrong about Chinese imports and other imported products as well. .............................................................................
Some things we can see and some we can't. But frequently it's the 'unseen' that makes all the difference.
Let's take low price Chinese imported goods as an example of this seen versus unseen story.
If the Chinese become zealous devotees of a religion whose doctrine requires that they serve Americans by shipping to Americans goods and services free of charge, then Americans are made better off. If the Chinese innovate in ways that lower their costs of production—and distribution and, thus, enable them to sell goods and services to Americans at lower prices—then Americans are made better off. If the Chinese invent new products and offer to sell these new products to Americans at prices that Americans find attractive, Americans are made better off. If the forces of international competition oblige Chinese producers to lower their export prices to levels closer to their costs of production, then Americans are made better off. If the Chinese government forces Chinese citizens to subsidize the production of goods and services sold to Americans so that Americans can purchase these goods and services at artificially low prices, then Americans are made better off (although Chinese citizens, other than those involved in the export trade, are made unjustifiably worse off). If the Chinese monetary authority buys U.S. dollars with newly created yuan in order to (of necessity temporarily) make Chinese exports artificially inexpensive for Americans to buy, then Americans are made better off (although Chinese citizens, other than those involved in the export trade, are made unjustifiably worse off).
The above reality is missed by people, such as Donald Trump (but hardly limited to him) who judge trade to be ‘successful’ only if the jobs and businesses that it visibly—that is, directly —creates in the domestic economy are perceived as being greater than the number of jobs and businesses that it visibly destroys. This error is among the oldest and most difficult to kill in economics—not only because this error is serviceable to domestic producers who greedily seek protection from competition, but also because it appeals to people who refuse to think beyond what is immediately and blindingly obvious."
Summing Up
To repeat, what we can't see immediately doesn't mean it's not there. It's just 'unseen.' That's true as well with respect to the impact of sustainable future low interest rates and the health of the American economy attributable to low cost imported products and services. Free markets work to the overall advantage of American society.
So if the Chinese are willing to supply American consumers with the world's best values, let's take them up on that.
And if they want to provide them essentially for free, that would be all the better for America's consumers.
But let's also get serious about upgrading the skills and knowledge of America's workforce and students.
That includes instilling in them the knowledge of how free market competition works to make a society's standard of living better.
By taking advantage of all the 'free' stuff offered by the Chinese, our citizens can then be free to focus on preparing themselves to perform higher value added work. That in turn will result in Americans having more money at their disposal to buy the low price Chinese offerings or anything else they may choose to buy.
But first, as Americans let's resolve to compete with all comers in a free and global market. That way we all win.
Stock prices in U.S. markets started off higher and ended lower yesterday.
Although U.S. stocks are set to open higher again today, we could be in for another 'up-then-down, down-then-up' episode of volatility today. Nobody knows.
In any event, markets fell in China today and are falling in Europe. In the U.S. prices are set to rise. See Global Stocks Struggle to Shrug Off China Fears which is subtitled 'European shares fall after another volatile session in China.'
A friend said recently that he had 'lost' $50,000 in the stock market. But did he really?
In other words, did he sell and realize the actual loss compared to what he paid for the shares, or does he still own the shares and have a currently unrealized 'paper' loss of $50,000? Or does the $50,000 even represent the difference between what he paid initially for the shares and what he received when he sold those same shares?
The prices that matter most are what we pay to buy shares and then what we receive when we sell them --- not the volatile pricing that inevitably occurs between those buy and sell dates.
The difference between what we pay and what we receive upon selling those shares is the actual REALIZED gain or loss on the principal amount of the shares owned. But that's not all.
We also need to take into account the cash dividends received during the time we owned the shares.
And that's why I'm staying invested in stocks for the long haul. Share prices over time will rise, and growing cash dividends will pay me along the way.
In fact, currently ten year U.S. government bonds yield ~2% and the dividend yield on blue chip stocks is ~3%. That's an increase of 50% in favor of stocks.
At the end of the ten years, the government will return my initial investment in bonds. At that time I'll need to find another investment for the money returned, assuming I don't need the entire amount in cash. And if interest rates increase in the interim, which they will, I'll receive less than $10,000 if the sale of the bonds occurs before the ten year bond maturity due date.
But with dividend paying stocks, cash dividends during those ten years will grow by perhaps 100%, thereby yielding ~6% on the initial investment. But what I like even more is the likelihood that the shares will then be worth more than double what I paid for them.
So here's the deal, fellow individual investors. If you need the money in the near term and the market sells appreciably higher today, then sell the shares and realize the gain or loss in relation to what you paid for the shares.
But if you have an unrealized paper loss compared to last month's price or even what you paid to buy those shares, then please carefully consider the genuine risk involved with emotionally driven selling in a volatile tradingmarket.
Market prices are extremely volatile right now, but over the long term the bigger and very real risk is in not owning a diversified basket of blue chip (1) dividend paying, (2) dividend growing and (3) REALIZABLE price adjusted inflation beating stocks.
Several years ago I read an extremely informative book which detailed the historical lessons to be learned from excessive debt levels of sovereign nations. The book is titled 'This Time Is Different: Eight Centuries of Financial Folly.'
The book's central theme is that after reviewing many centuries of various nations' accumulated excessive debt levels, 'this time' is never different. The story always and invariably ends in financial disaster for the excessively indebted countries.
What we don't know and never really can know, however, is exactly when the disaster will strike.
And that brings us to today's debt ridden situation in China and much of the rest of the world as well. While we don't and can't know when the bad ending will occur, we do know what's ahead.
Debt is never a free lunch for individuals, communities, states or sovereign nations.
The good news for America, however, is that we still have time to clean up our act and stop relying too heavily on government spending and the public sector. While we can't be optimistic about all that, we can look forward to low inflation, low interest rates, low energy prices and relatively inexpensive imported products due to low price commodities.
China's excess capacity is the American consumer's friend.
A Warning on China Seems Prescient summarizes the debt issues confronting China and why this will present huge problems for our global economy in future years:
"Kenneth Rogoff has long warned of a potential financial crisis in China.
Mr. Rogoff, a professor of economics at Harvard University, . . . for years has been telling anyone who would listen that China posed the next big threat to the global economy. He is starting to look right, again.
“In economics, things take longer to happen than you think they will, and then they happen faster than you thought they could,” Mr. Rogoff said . . . .
Mr. Rogoff . . . has made a career of studying financial crises. After the 2008 financial crisis, Mr. Rogoff co-wrote “This Time Is Different,” a seminal book that examined eight centuries of financial crises.
Every financial crisis, he and his co-author, Carmen M. Reinhart, concluded, stems from the same simple problem: too much debt. . . .
“China is the classic ‘This time is different’ story,” Mr. Rogoff said, rattling off all the different rationalizations for why the country convinced itself — and many others — that it could load up on debt but was somehow immune to the laws of economic gravity. He cited the government’s control over the markets, the hundreds of millions of workers migrating to cities and the country’s saving rate of about 30 percent of disposable income as just some of the reasons China was said to be impervious to a severe downturn.
“It’s very vulnerable,” Mr. Rogoff added. “There is a lot of debt.
How much debt remains an open question, given the opacity of China’s market. The country’s debt load rose from $7 trillion in 2007 to $28 trillion by mid-2014, according to a report published earlier this year by the consulting firm McKinsey & Company, China. “At 282 percent of G.D.P., China’s debt as a share of G.D.P., while manageable, is larger than that of the United States or Germany,” said the McKinsey study. “Several factors are worrisome: Half of loans are linked directly or indirectly to China’s real estate market, unregulated shadow banking accounts for nearly half of new lending, and the debt of many local governments is likely unsustainable.”
The question then becomes how interconnected China’s economy is to the rest of the world. . . .
“How does all that ricochet to emerging markets?” Mr. Rogoff said in discussing the effect of China’s slowdown on commodity producers like Brazil, whose economy is in a tailspin. “Look at Russia. It’s amazing they haven’t had a financial crisis yet.”
Mr. Rogoff is not the first person to identify China as a potential risk. Earlier this year, this column highlighted the views of Henry M. Paulson Jr., the former Treasury secretary and a Sinophile, who said, “Frankly, it’s not a question of if, but when, China’s financial system will face a reckoning and have to contend with a wave of credit losses and debt restructurings.” And the hedge fund manager James Chanos has been sounding the alarm on China for years, recently declaring, “Whatever you might think, it’s worse.”
There are, of course, significant political reasons China needs to convince the world and its own citizens that it can manage its convulsing financial markets and slowing economy. “Financial meltdown leads to a social meltdown, which leads to a political meltdown,” Mr. Rogoff said. “That’s the real fear.”. . .
So does Mr. Rogoff believe that China is headed for a terrible “hard landing” that will lead to a
global recession?
Well, despite the market tumult and his persistent warnings, Mr. Rogoff says he believes that the last several weeks have raised the prospects of a meaningful crisis. But with China’s trillions of dollars in reserves, he thinks the country may have sufficient tools to prevent a calamity that spreads across the globe — at least for now.
“If you had to bet,” Mr. Rogoff said, “you’d still bet they’d pull it out.”"
Summing Up
China has a great deal of currently underutilized manufacturing capacity and too many indebted government entities, especially municipalities.
In plain terms, the Chinese have an excessively troublesome and perhaps unsustainable debt load.
Other nations that act as suppliers to China of oil and other commodities (Russia, Brazil, OPEC, Venezuela, Australia, Iraq, Iran and so forth) are likely to have huge issues in their own economies as Chinese growth slows, its purchases slow, and its capacity underutilization issues remain unsolved.
On the other hand, American consumers should be the primary beneficiaries of all this global 'deflationary' activity.
It looks like it's going to be a good day in the U. S. stock market after another bad day of trading for Chinese investors.
U.S. stock prices are set to rebound, and the Chinese just announced more 'stimulus' programs cutting interest rates and injecting liquidity into their financial system.
"The People's Bank of China on Tuesday announced cuts to benchmark interest rates, lowering its lending and deposit rates by 0.25 percentage point. The rate cuts are effective on Wednesday and aimed at reducing corporate borrowing costs, the bank said, according to Dow Jones Newswires reports. China's central bank also reduced its reserve requirement ratio by 0.5 percentage point, with that requirement effective on Sept. 6. The reserve cuts are meant to ensure enough liquidity and stable credit growth, the bank said. The move comes after a session in which the Shanghai Composite plunged 7.6%, bringing two-day losses top more than 15%. U.S. stock futures, which were surging before the China news, added to those gains."
Although predicting anything these days about short term market moves is especially dangerous, we could see much, if not all, of yesterday's decline erased by the end of trading today.
That would be a stabilizing event but won't solve the world's financial problems.
Meanwhile, oil remains below $40 per barrel and China's stock market and economy may be in big trouble.
The storm isn't over for us, but the news today should be better --- much better --- than it has been the past few days.
In any event, as long term individual investors, we'll stay the course.
"I love spending time in the mountains. So a few weeks ago, I jumped at the opportunity to join a friend, my son and seven of his friends on a trip into the Uinta Mountains. This range sits about an hour east of our home in Park City, Utah.
We planned the trip to last three days with hikes of 10 to 13 miles each day. All of us carried heavy packs. On the second day, we’d set a particularly big goal: 13 miles, three mountain passes, 6,000 vertical feet and a one-mile side trip to the summit of Kings Peak.
At 13,528 feet, Kings Peak is the tallest mountain in Utah, and the entire ridgeline trail sits above the tree line. We had a clear view of the whole path, and it was a daunting sight. We all felt a little overwhelmed.
My son Sam commented afterward that he managed the hike by focusing on what was right in front of him. Instead of focusing on the peak or the trail far ahead, he chatted with his friends and paid attention to what was happening around him.
His strategy worked so well that I think he was a little surprised at how good he felt when we finished the hike. Yes, it was hard. But what appeared impossible in the morning turned out to be very manageable.
Something else came into play on our trip: afternoon thunderstorms. Without fail, the clouds would roll in during the afternoon, and I found myself worrying about the rain and lightning. If it rained, we’d be miserable. Throw in some lightning, and we might need to retreat from the ridge to find shelter.
As I worked through all the possible scenarios in my head, I forgot something pretty important: It wasn’t raining! They were only clouds. With a little nudge from Mother Nature, I created a problem in my head that didn’t even exist. I reminded myself that we’d planned for the possibility of rain. We had raincoats. We wouldn’t melt. And we had a strategy if lightning started.
So I took a deep breath and tried to ignore the clouds. Despite all my worrying, it didn’t rain once even though clouds surrounded us every day.
I find it fascinating how we get distracted by things that might happen, often to the point that we overlook what’s right in front of us. We do this a lot with money. We focus on big financial goals, like buying a home, paying for college, or retiring — and they seem so big we convince ourselves they’re impossible to reach. Then, because we feel overwhelmed, we stop trying to reach them.
Look, it’s important to know where we want to go and to set goals to get there, but we can’t let that big thing way off in the future intimidate us. We could lie in bed every night worrying about how we’ll get there, or we could follow my son’s approach: Keep our heads down and focus on the next step and then the step after that one.
I think back to some of my earliest clients and where they started 15 years ago. If you’d told them then where they’d be today, they’d have said, “No way. That’s impossible.” But the impossible became reality because they put their heads down and committed to do the small, simple things, like automating their savings each month.
They didn’t get distracted or overwhelmed by the big goals. They also managed to avoid creating problems that existed only in their minds. They just focused on what they could control every day, every week and every month. Now, 15 years later, they’ve reached many of the audacious goals they set a long time ago.
We’re all capable of the same success. Over time, of course, we’ll need to peek at that big goal on the horizon and see if we need to make a course correction to avoid a real problem. Unexpected setbacks will occur, and we might need to adjust the timeline. But the rest of the time, we need to keep putting one foot in front of the other and stay focused on one question: What can I control today?"
Summing Up
Here's the moral to the story.
We shouldn't worry about those things we can't control.
The short term movements of the stock market are among those things that we can't control.
We should take the time to take care of today's business and keep an eye firmly fixed on our long term goals.
Saving and investing in a diversified portfolio of blue chip dividend paying stocks should be 'today's business' for all of us who are concerned about the future well being of our families.
So we should stay in the game today, because if we stop and get out, it's almost a certainty that we won't get back in before the market resumes its upward trend.
Stock markets around the world fell heavily this past week, and the U.S. was no exception. It's likely that we will experience much turmoil and pricing volatility, both up and down, in coming weeks.
Oil prices and other commodities have fallen hard, and they appear to be headed lower.
But it's not all bad news. Gasoline at less than $2 per gallon in the near future looks like a very good bet, and prices for many imported products will remain stable or even go lower as low commodity costs and the strong dollar combine to increase consumer purchasing power. Meanwhile, interest rates will stay low for the next several years (even after a small bump by the Federal Reserve in either September or December).
Now we come to the cause for all the current angst --- excepting the U.S., a slowing global economy combined with uncertain and confused leadership in Communist China. A definite slowdown in China's growth and domestic unrest have created political problems which are the most likely cause of the current global stock market woes. The phrase 'He who rides a tiger may not dismount' seems to fit as China's leadership definitely has an economic and domestic tiger by the tail.
That in turn is creating much turmoil in emerging market economies as those countries try to compete with the Chinese to produce and export more 'stuff' to America and other developed countries. Accordingly, a race to the bottom for the affected currencies is a distinct possibility and concern. In any event, great turmoil in the bonds of those countries that have borrowed and owe U.S. dollars will now unfold as, due to the continuing strength of the dollar, their debts will rapidly grow in their own currencies, perhaps generating bond defaults and causing more trouble for bond investors down the road.
But here's the deal, my fellow American stock investors. The U.S. is doing better than all the rest with respect to economic growth, the dollar will stay strong, energy and other commodity prices will go lower, and U.S. interest rates and borrowing costs will stay low. And finally, economic growth and the jobs market in the U.S. will continue to improve modestly as inflation is nowhere on the horizon. To repeat, we can expect a modestly growing U.S. economy, albeit confronted with the potential of global deflation resulting from low oil prices, low commodity prices and the general economic slowing in the rest of the world, especially China. In the meantime, American consumers this Christmas season will have more money to spend as gasoline prices fall well below $2 per gallon, interest rates remain low and prices of imported consumer goods are affordable.
But what will happen to our stock market the next few weeks or months? The simple answer is that nobody knows. Over the long haul, however, low inflation and low interest rates coupled with a growing U.S. economy and jobs market indicate that the U.S. should be fine.
Our biggest long term problems in need of solutions are the overall individual debt dependency and government spending levels. Those long existing issues aren't new for us, of course, but they definitely are troubling.
With that in mind, let's take a look at what individual investors should do with their money right now. Doing nothing is my plan of inaction, and I'll explain why you may wish to consider a similar approach in this season of angst.
"5 --- After a market drop, or at any other time, no one knows what the market will do next. The one thing you can be fairly sure of is that the louder and more forcefully a market pundit voices his certainty about what is going to happen next, the more likely it is that he will turn out to be wrong. Stocks could drop another 10% from here, or another 25% or 50%; they could stay flat; or they could go right back up again. Diversification and patience — and, above all, self-knowledge — are your best weapons against this irreducible uncertainty."
The 3.2 percent drop in the Standard & Poor’s 500-stock index on Friday culminated the worst week for United States stocks since 2011, and put the index 7.5 percent below its recent peak on May 21. Many global markets have performed even worse, with stocks down across Asia and Europe. And the price of oil and emerging market currencies around the world continued a decline that dates to last year. . . .
Market commentators offer a range of specific explanations for the sell-off, including a drop in oil prices thanks to a global supply glut (which will affect the profits of energy companies and oil-dependent emerging markets alike), a slowdown in the Chinese economy that is becoming more apparent by the day, and a credit squeeze in other emerging markets. But those explanations, while accurate, are part of a bigger story. . . .
The United States stock market, as measured by the S.&P. 500 . . . fell 5.8 percent this week and is now down 4 percent for the year. But that only pulls the index down to October 2014 levels. Against a longer time horizon, the recent drop looks more like a trivial downward bounce within a consistent range rather than something more dire.
Flat stock prices in 2015 mask what came before: a remarkable run-up in stock prices in the preceding half-decade. From mid-2009 to mid-2014, stock prices rose much faster than corporate earnings, or gross domestic product, or pretty much anything else you might think of as fundamentals. . . .
A mix of interventionist policies from the Federal Reserve and other central banks, and a global glut of investment capital have created a mismatch between the global economy, which has grown glacially, and markets, which have been on fire.
As Josh Brown of Ritholtz Wealth Management tweeted on Friday, “2015 is the first year since the recovery began where the real economy is outperforming the financial economy.”
The big question now is whether the fundamentals driving the recent sell-off — the oil glut, the emerging market strains — get worse or better. That matters a lot for businesses and individuals in China and other countries under stress, and for oil producers globally. But for the United States economy and even for most companies traded on American exchanges, it’s much less clear that it should create a major hit.
Consider that in 1997 and 1998, an emerging markets crisis rippled across East Asia and Russia. It turned out that 1999 was a blockbuster year for United States economic growth and corporate earnings anyway.
In the meantime, the best response for most investors trying to grapple with the latest bout of volatility is to take a deep breath, appreciate the remarkable run-up of the last five years, and remember that if you panic at the thought of losing 6 percent of your money in a week, that money really shouldn’t be invested in the stock market to begin with."
Emotionally driven buying and selling, and short term knee jerk reactions to stock market moves don't make for successful long term individual investing results.
My plan has long been to own shares of a diversified portfolio consisting of solid blue chip companies which over time grow their sales and earnings, and pay increasing cash dividends.
These companies are able to pay those dividends as a result of long term oriented earnings growth, and this earnings growth in turn results in large measure from sales growth.
The sales growth comes from a combination of general economic growth as well as the competitive position of the company in the markets where it participates.
Stock prices over time are a result of both the overall economy's long term health and the individual health of the specific company.
Our U.S. economic health is improving, albeit slowly.
Since I'm in it for the long haul, what happened in the stock market last week or what happens next week won't cause me to panic and sell.
Of course, it's no fun watching stock prices fall, but neither is it fun watching our politicians make things harder for companies to succeed.
That said, at least we're not being governed by China's Communist Party.
