The Coronavirus Crisis: How the Trump Administration is Pushing Stock Prices Down

The financial markets hate uncertainty.  When the picture isn't clear, stock prices get wobbly.  Before today, the coronavirus epidemic had already pushed stocks into a correction (i.e., a drop of 10% or more).  To make things worse, the Trump Administration has been trying to downplay the scope, risks and impact of the epidemic while federal health officials have endeavored to be realistic.  (See https://www.cnn.com/2020/03/09/politics/cdc-policy-test-kits-coronavirus/index.html.)  This informational squabble cast doubt where doubt could do the most harm.

The coronavirus epidemic is the largest driving force in the stock market today.  The disease has slowed the world economy and sharply reduced demand for petroleum, which has hit oil prices hard.  Major oil producing nations, including the members of OPEC and Russia, tried to work out a way to prop up oil prices this past weekend but failed.  This morning, oil prices plummeted into the $30 to $35 range for West Texas Intermediate.  That implies gas prices around $1.50 to $1.60 per gallon, compared to current retail prices around $2.20 to $2.50 in many parts of the country. 

The cratering oil prices exerted fresh downward pressure on stock prices today, so much so that a stock market circuit breaker was triggered for the first time after the S&P 500 fell 7%.  Trading was halted for 15 minutes and then resumed, with stock prices remaining moribund. 

When the markets don't have adequate information, investors are cautious about the prices they'll pay.  When a flood of selling takes place because of inadequate information, buyers will be reluctant to step forward and invest, even when prices drop significantly.  Holders of stocks, faced with uncertainty over the future, will be inclined to sell even more rather than run the risk of additional losses.  Fear spreads and selling increases.  Had the Trump Administration been forthright about the coronavirus epidemic, stock prices would have been impacted, but investors would have been more confident about stepping in and buying.  By creating an informational fog, the Trump Administration exacerbated selling pressure and dampened buying interest.  This is no way to restore confidence in the market.

The Trump Administration is certainly not the only government that has been economical with candor concerning the coronavirus epidemic.  The combined governmental obfuscation has been precisely what stock prices don't need.  But there are few signs of unvarnished governmental veracity on the horizon.  Expect more nausea in the markets.

Coronavirus and the Perils of Pricing Stocks for Perfection

The past week's tailspin of stocks into a correction is a reminder that the law of gravity has not been repealed in the financial world.  Until just recently, the high flying stock market, having steadily risen since 2009, was priced for perfection:  everything had to go well or gravity would assert itself.  In such circumstances, bad news can have an outsized effect.

Not surprisingly, the trigger for the downturn was a black swan--a stock market term for an unexpected event that is very bad for the market.  Typically, black swans are the triggering events for sudden market nosedives.  The 2008 bear market that coincided with the beginning of the Great Recession was triggered by losses hitting a poorly understood cobweb of linkages between and among the real estate, mortgage, bond and derivatives markets that concentrated real estate lending risks into the heart of the financial system.  Large mortgage losses were magnified into a tsunami of financial pain by daisy chains of supposedly offsetting derivatives contracts that wound up consolidating risk instead of dispersing it.

Coronavirus (or COVID-19) is today's black bird.  It calamitously began in the world's factory, China.  This meant that it would spread quickly because so much global commerce--and therefore global travel--would circulate through China.  Its high rate of transmission was not fully appreciated at first, and those giving early warning were treated as Cassandras instead of being taken seriously.  So the disease spread quickly and a massive shutdown of major parts of China was imposed.  Commerce slowed precipitously and corporate losses are piling up fast.  The World Health Organization has warned that the disease has become a very high risk.  In short, coronavirus is on the verge of becoming a pandemic, and the prognosis is guarded.

The stock market finally got the message, and had a hissy fit, dropping into a correction in five trading days.  More losses are likely in the near term future.  Opinion is divided on whether the current market is a buying opportunity or a septic facility to be avoided.  If you're set on putting money into this market, make sure it's money you won't need for at least ten years.  Medical science is getting a better understanding of COVID-19 by the day, and chances seem good that eventually we will learn to cope with the disease and contain its impact.  But when that day will be remains speculative, and you should speculate only with long term money that you can afford to lose.

Do the Unicorns Signal a Market Peak?

Unicorns in the financial markets bear scant resemblance to the gentle creatures of mythology.  Companies with private valuations of $1 billion or more, called "unicorns" by investors, have been going public recently after many years of incubation by private funding.  The results haven't been pretty.  Two of the largest--Lyft and Uber--have lost value.  Snap, another large company that went public a couple of years ago, has also lost value. The sagging values of these high profile companies raise a question whether investor confidence is receding and the market is potentially headed for a downturn.

Much of the reason for the price drops is attributed to the long incubation periods for these companies, during which their values rose into the billions.  Whereas 20 or 25 years ago, companies might go public after having achieved valuations of a few tens of millions, unicorns have provided enormous returns to venture capitalists, early employees and other private investors before the retail schlemiel is given a chance to lose his money.  In other words, the upside pop that often accompanied ipo's in the past has already been pocketed by the smart money.  What remains for Ma and Pa trying put a little money into their IRAs is the uncertainty of companies that have yet to consistently turn a profit.

A hot ipo market fuels overall stock values.  Look at the 1990's, when ipo enthusiasm grew so vast that things got out of hand and the 2000-01 downturn took some 70% off the value of the Nasdaq index.  The recent unicorn fails will dampen further ipo activity.  The smart money was too clever by half in using ipo's as a way to vividly demonstrate to retail investors that they are but a septic system for the rich and well-connected. As President Trump's trade wars continue, the chances for a no-deal Brexit increase, and investor enthusiasm wane, the chances for a significant market downturn rise.  The unicorn ipos may signal a peak in stock prices.  Embrace cash.  In uncertain times, it's worth its weight in gold.

How Donald Trump Could Create a Stock Market Crash

Stock market crashes, such as in 2008, emanate from inflated asset prices.  While economic recessions and other events, such as war, can trigger market downturns, large, sharp market drops (a/k/a crashes) are the result of artificially high asset prices that often have started bubbling.  In 2008, the asset bubbles resulted from overly generous prices being paid for real estate, the resulting mortgages, stocks that seemed like good bets in light of all the real estate activity, and stocks generally because market averages kept rising.  It didn't help that the U.S. government guaranteed almost all mortgages on a de facto or de jure basis.  The easiest way to get people to pay too much for an asset is to make it seem like a sure bet.  Con men know this and profit from it because, despite all the evidence that there is no such thing as a sure bet except taxes and death, people remain suckers for sure bets. 

Donald Trump bet the image of his Presidency on the rising stock market.  Stocks rose briskly right after Election Day in 2016 and maintained their upward momentum for over a year.  Trump noisily celebrated the huzzahs he thought he heard from the financial markets and wore out the fabric of his suit jackets patting himself on the back.

But Trump, despite decades as a New York businessman, hasn't absorbed a simple lesson that he should have learned about stocks a long time ago:   that stocks go up and stocks go down.  There is no such thing in the stock markets as continuing upward momentum.  There is no endless applause.

So, when the stock markets got tummy trouble in 2018, and began to burp, belch and make other inelegant noises, Trump became discombobulated.  He berated the Federal Reserve Board for raising interest rates, manipulated oil prices down by persuading the Saudis to keep pumping large volumes, and condemned American businesses that closed down domestic operations.  Sometimes, on down days in the market, he made statements about trade talks that turned out to be optimistic or premature.  He seemed indifferent to widening federal deficits, instead suggesting a further tax cut for the middle class.  All of these actions seem linked to a desire to support stock prices.  But stocks have remained gloomy.  So we can expect that Trump will keep searching for some way to boost the metric that he thought made him look so good.

Persistent efforts by governments to support and boost asset prices have tended to end badly.  There is no free lunch, and governmental distortion of asset prices inevitably leads to misallocation of capital and other resources.  Pushed far enough, this mispricing eventually becomes too much for investors to stomach, and they back away from the asset. Then, bad things happen to the asset's price. That happened with real estate and mortgages in 2008 and it may be happening with stocks now.  If Trump pushes too hard on maintaining and increasing stock prices, he could foster a bubble in the stock markets, and nothing good for him will result from that.  If you're an investor, don't bet on governmental action to make stocks great again.  Remember:  in the final analysis, stocks go up and stocks go down.

The Best Asset in a Time of Volatility

All markets are volatile these days.  Stocks are gyrating, bonds are falling as interest rates increase, oil is bouncing up and then down, bitcoin has fallen all year, and even the real estate market seems to be going wobbly.  Gold and silver have been slipping away.  And foreign markets look even gloomier.

Investors naturally look for opportunities when prices fluctuate.  Whether you're a buyer or a short seller, price movements create the potential for profit.  Volatility is gut wrenching if you're taking losses, and can stimulate panicky selling when prices are low.  But it can be exhilarating if it looks like a lucky break.

That's why cash is often the best asset to hold in a time of volatility.  It gives you the means to take advantage of fortuitous price movements, while its stability insulates you from the emotional roller coaster that often drives people to sell when prices are dropping.  Don't think that you have to remain fully invested all the time.  What you have to do is remain unemotional, as emotion is the enemy of careful investing.  A nice, comforting cushion of cash can prevent an unwanted flood of adrenaline.

Cash may appear to have a low rate of return, with greedy banks still paying miserly rates of interest on deposits even though interest rates have been rising.  But cash also offers the potential to profit from price volatility.  You can dive into an asset when its price is low and make a bundle when it rebounds.   That potential makes the effective return from cash much higher.  So don't be afraid to hold a lot of cash in a time of volatility.  That's when it's an investor's best friend.

The Cryptocurrency Bust

Cryptocurrencies are down about 75% from the beginning of the year.  See https://www.cnbc.com/2018/08/20/after-the-bitcoin-boom-hard-lessons-for-cryptocurrency-investors.html.  Many investors have taken losses in the range of 70% to 90%.  Those who borrowed to buy cryptocurrencies learned the hard way that investments may or may not work out, but debts have to be repaid either way.  There may be some winners, but clearly there are plenty of losers.

The problem with cryptocurrencies is that they basically have no intrinsic value.  They're only worth what someone else will pay for them.  If buyer interest falls, people holding cryptocurrencies end up holding the bag.  If you want to buy cryptocurrencies, that's your choice.  But understand it's a speculative choice and lots of speculations end badly. 

The reason why stocks, bonds, real estate and a few other things have stood the test of time as good investments is they generally have underlying value.  If you want to build wealth, invest in value.  If you want to speculate, hope to win but don't be surprised if you lose.  If you want a decent retirement, avoid wishful thinking and focus on the higher percentage plays.  See  http://blogger.uncleleosden.com/2009/11/techniques-for-retirement-saving.html.

To Manage Your Money, Manage Your Emotions

Building up your wealth is simple:  spend less than you get.  But it's hard for many people even though it's simple.  Put a little money in their hands and it's gone as quick as a flash.  Put a lot of money in their hands and it's gone quicker than a flash.  This is no way to get rich.  If you spend everything you get, how will you put together a down payment for a house, college costs for your kid(s), or retirement?  Sometimes, you can borrow.  But loans have to be repaid, so you'll enrich banks, not yourself.  Retirement on just Social Security can be okay--if you move to Panama or Cambodia, places where your only option may be McDonald's if you want a taste of America.

Controlling your spending is the first and most important step to building wealth.  Don't begin by reading the vast array of materials that discuss how to invest.  It doesn't matter how you make money investing in ETFs, mutual funds, S&P 500 futures contracts, or covered stock options if you don't have any capital to invest. 

First, learn how to save.  This means getting control over your emotions.  Learn how to deny yourself immediate gratification.  Learn how to value long term rewards.  Learn how to ignore the latest trends.  Learn that keeping up with the neighbors could mean you're just as foolish as the neighbors.  Aside from basic spending for food, shelter, clothing and transportation,  essentially all spending decisions are driven by emotion.  The latest smart phone?  Designer clothes and accessories?  The trendiest restaurant?  A luxury nameplate on your car?  An extra 500 square feet in your house?   These things are marketed to people with impulse control problems.  Status won't give you a comfortable retirement.  You need money for that.

You've probably seen the news stories reporting that half of all Americans have no retirement savings and most of the rest don't have very much.  How could this be when America is one of the wealthiest nations in the world?  The hard truth is most people don't have the emotional composition to get rich.  And they don't have the willpower to get control over their emotions enough to begin the process of saving.  Sure, an illness or layoff can wreck your financial plans.  But they're not an excuse not to try.  If you don't try, you'll fail for sure.  Those who try actually succeed in many cases.  Give yourself a chance.  Get control over your spending impulses and save.  The only people who laugh all the way to the bank are people who have money to deposit in the bank. 

For more, see (a) http://blogger.uncleleosden.com/2009/07/simplest-financial-plan-of-all.html; (b) http://blogger.uncleleosden.com/2010/07/how-to-think-about-saving.html; (c) http://blogger.uncleleosden.com/2011/01/hope-for-financially-lost.html; (d) http://blogger.uncleleosden.com/2009/11/techniques-for-retirement-saving.html; (e) http://blogger.uncleleosden.com/2011/03/how-to-avoid-running-out-of-money-in.html; and (f) http://blogger.uncleleosden.com/2010/11/how-much-do-you-need-for-retirement.html.

Is Inflation Hitting Bitcoin?

Bitcoin is supposed to be insulated from inflation.  Because there is a predetermined limit to the number of Bitcoins that can be created (21 million), Bitcoin supposedly should not be subject to anything like the monetary actions of governments, which can inflate fiat currencies by printing more money.  There was an operational problem in August 2010, when someone created 184 million Bitcoins in a single transaction.  But this transaction was voided and the operational problem dealt with.  Thus, the 21 million coin limit was preserved.

Nevertheless, Bitcoin is subject to inflation risk.  Inflation results from increasing the amount of a currency.  Although the number of Bitcoins is limited, the number of digital alternatives to Bitcoin is not.  Other cryptocurrencies, such as Ethereum, can be created with relative ease.  There are few barriers to entry.  Some 1100 cryptocurrencies now exist.  Among them is Bitcoin cash, created by the Bitcoin community with features that make it easier than Bitcoin to use for transactions.  The Bitcoin community also created Bitcoin gold, a cryptocurrency created to facilitate decentralized mining (Bitcoin itself is now dominated by a small number of large miners).  As these alternatives proliferate, the value of Bitcoin can fluctuate wildly.

So far, Bitcoin has recovered from its sharp drops, and continued an overall upward trend in value.  But volatility attracts fast money, and cash seems to be flowing into the Bitcoin market for speculative purposes.  This may not end well.  Hot money never stays in one place for long.  With all the alternatives to Bitcoin, and the low barriers to entry for more, numerous other venues for volatility and speculation are or will become available.  Speculators will stampede to whatever market appears to offer larger and quicker profits.  The effect on Bitcoin could be similar to inflation.  As cash flows away from Bitcoin, its value will diminish.  Pause and think before you buy Bitcoins.

Hurricane Harvey? North Korean Missiles? Stocks Shrug

So, okay, Hurricane Harvey may be the worst storm to hit America in a while.  The damage is really bad, and getting worse.  Projections for recovery time are lengthening by the minute as rainfall totals rise.  The economic impact will clearly be big.  Energy extraction and refining are being hit.  The Gulf states have a number of petrochemical and plastics plants, but they aren't manufacturing much.  The Gulf ports are major transshipment points for a lot of stuff, but not much transshipment is taking place.  The cost of rebuilding may reach $100 billion or more.

Meanwhile, the fat kid in North Korea keeps firing off missiles, in one instance over northern Japan.  He may think he's being clever, pushing the world to see how far he can go.  But shooting missiles over another country is a way to start wars.  The Japanese held their fire.  But North Korea's missiles aren't the picture of reliability and sturdiness.  If one flies in an unintended trajectory, or falls apart at the wrong time, physical impact on Japan or maybe South Korea is quite possible.  Then what?  Kim Jong Un has been on a path of escalation in recent months.  He's announced that Guam--U.S. territory--is his next target.  Since he seems intent on escalating, he will approach a flashpoint. 

But do stocks care?  Not one bit.  Even though U.S. stock futures dropped sharply last night, all indexes closed up today.  Mega hurricane--meh.  Barrage of North Korean missiles--meh.  Discord rife between and among the President, Congress and both political parties--meh.  Merrily we roll along.  Plus ca change, plus c'est la meme chose. 

Why do we have such insouciant stocks?  The likely explanation is the Fed.  Market participants have gotten so used to Fed bailouts that no one believes stock indexes can fall more than about 3% at the most, and therefore don't panic sell portfolios.  In some respects, this market stability may seem desirable. 

But market stability based on government subsidies is ultimately chimerical.  The Fed produced that stability by screwing over large numbers of people.  By keeping interest rates extraordinarily low for almost a decade now, the Fed has decimated pension plans.  A lot of middle class people who depended on their pensions are now lower middle class, or even poor.  Retirees and others who relied in part on interest income from their savings have learned to like dog food in lieu of steak, or even hamburger.  Holders of long term care insurance policies have faced extortionate rate increases, or possibly the prospect of spending old age in homeless shelters until they qualify for nursing homes that take Medicaid (which sometimes aren't exactly top class institutions).  Those that still have some faith in the future and want to save for a rainy day need to tighten their belts and put aside more principal, rather than count on the compounding of interest income to make their golden years glow.  That means reducing current consumption, which is a drag on the economy and may partially explain why economic growth remains tepid.

As long as the Fed supplies financial opioids for stocks to mainline, the market will be copacetic.  But problems lurk.  Stock valuations may not truly reflect investment values.  Instead, they probably incorporate a large dose of government subsidy.  That would mean people are paying too much for stocks.  This story won't have a happy ending.  Market forces can't stay suppressed indefinitely and government subsidies can't last forever.  The failure of Communism in China and the Soviet Union prove that point.  Things generally feel good when you're on narcotics. But you don't get good quality sleep on opioids--and investors shouldn't be sleeping too soundly now.

The Truth About Getting Rich

Wealth is relative.  That is, people tend to consider themselves wealthy by comparing themselves to those around them.  The fact that most people today live healthier, longer and more comfortable lives than King Henry the Eighth is irrelevant to them.  They care more about where they stand compared to the people next door or the colleague across the hall or the persons featured in today's news.

This means you can feel rich only if you have more wealth than others around you.  That, in turn, means you have to be different from most people.  You can't be just like everyone else and yet be wealthier than everyone else.  But if you see yourself as just an ordinary, middle class person, does that mean you haven't got a chance to be wealthy?

No.  You can be wealthy.  While some wealthy people inherit their riches, most millionaires get there on their own by saving more.  It helps if you earn more.  You'll have more money to work with.  But earning more helps only if you save more.   If you spend all your above average earnings, expect to dine on dog food in your retirement.

You have to resist temptation to spend.  An 856 inch big-screen TV and a 4,300 horsepower SUV won't make you wealthy.  The same goes for $700 shoes and $1,200 handbags.  You have to be comfortable with fewer European vacations and plenty of home cooking.  When people laugh at your frugal ways, you have to focus on getting the last laugh.

Most people won't make it.  They won't become wealthy.  That's inherent in the definition of wealth as a relative concept, and it's also a result of the human tendency toward conformity and group think.  But plenty of middle class people end up having comfortable retirements or better.  In part, that's because of social welfare programs like Social Security and Medicare.  But these programs alone don't provide a good retirement.  You must be responsible and save.

What to do?  It's not complicated.  The main thing is save early, often and in significant amounts, like 15% to 20% of your income.  Invest in a diversified portfolio to increase your chances for good long term returns.  (See http://blogger.uncleleosden.com/2009/07/simplest-financial-plan-of-all.html.)   There are a variety of ways to build up your wealth:  http://blogger.uncleleosden.com/2009/11/techniques-for-retirement-saving.html.  Look at each dollar you receive as a saving opportunity.  Remember that no matter how much money you make,  in the end you will have a finite income (we all do), and what you spend can't be retrieved.  It's gone. So don't waste that opportunity to save (see http://blogger.uncleleosden.com/2010/07/how-to-think-about-saving.html).  Avoid debt as much as possible (see http://blogger.uncleleosden.com/2010/07/why-you-should-avoid-debt.html).  Don't give up, even if you have financial setbacks.  Like so many other things in life, quitters aren't winners when it comes to building wealth.

You can have a somewhat decent retirement even if you don't save much, by building up your benefits and eliminating debt. (See http://blogger.uncleleosden.com/2011/01/hope-for-financially-lost.html).  But if you want to climb into the ranks of the wealthy, be different.

Investing in a Time of Trump

If there's one notable feature of investing in the nascent Trump Presidency, it's uncertainty.  Although macroeconomic statistics are generally good, we are startled every day by a spinning kaleidoscope of tweets, leaks, executive orders, allegations, innuendoes, news stories, fake news stories and occasional court rulings that splatter across our field of vision and further contort the cognitive dissonance in the political scene from the recent election.  When all news and news-substitutes seem to be open to challenge, what can an investor rely on?

The ever-rising market only makes things worse.  With such political confusion, it's far from clear that the economic and tax policies espoused by President Trump will be implemented any time soon.  Why does the market persistently climb higher?  One can only suspect that some market participants have conflated optimism with delusion.  The background music to today's market may not be the Grand March from Aida (https://www.youtube.com/watch?v=TX0qN6QEvGg), but rather Jimi Hendrix's Purple Haze (https://www.youtube.com/watch?v=cJunCsrhJjg).

What can an investor make of all this?  Bear in mind that you can't see a lot of what's going on in the market.  There are major undercurrents, often computer driven, that cause daily market schizophrenia.  Large investors can push the market one way or another in the course of making large purchases or unwinding large holdings.  Mom and Pop investors won't see this or hear about, except maybe after the fact.

Computerized trading can be particularly scary.  It no longer consists of following pre-determined algorithms.  Much of today's computerized trading is dynamic, using artificial intelligence-type programs that try to figure out as the trading day progresses where prices are headed and buy or sell to take advantage of the anticipated market move.  Since much of the trading these programs are observing is done by other computers, we have computers reacting to other computers.  Price, which traditionally has been a judgment call made by intuitive and irrational humans, is now the product of chains of logic.  That logic tends to respond to short term stimuli, such as price movements in the last few minutes, seconds and even milliseconds.  It doesn't factor in the uncertainty in Washington.

People know the future is cloudy.  But the computers don't.  Computers don't feel fear, nor do they have to save for retirement or build up a cash reserve to guard against a layoff or a large unexpected expense.  People may hold onto their cash, wondering if the market is too bubbling given the chaos in the White House.  But a computer may boldly keep buying, egged on by the trades of the past 20 milliseconds.

If you're hesitant about the market, keep your powder dry and your cash in an FDIC guaranteed bank account.  There's no computer program that can understand and explain Donald Trump.  Today's stock market may be too heavily driven by short term inputs, without a full understanding of longer term risks.  Remember the old computer adage: garbage in, garbage out.  If today's computerized trading is pushing the market up based on an incomplete picture, prices will eventually rise too far, if they haven't already.  Then, le deluge.

Is the Fed Undermining Portfolio Diversification?

A basic investment strategy for investors is to diversify.  Typically, investors put some of their money into stocks, and most of the rest into bonds.  Small portions may go into gold or other commodities, or be held as cash.  Stocks and bonds historically have tended to offset each other.  When stocks rose, bonds would fall, and vice versa.  A diversified portfolio would be hedged, ameliorating the ups and downs of the market and making investing less stressful. 

Today, though, central bank accommodation--in the form of ultra low interest rates, negative interest rates and quantitative easing--has distorted this historical relationship.  As the Fed and other central banks print more and more money, both stocks and bonds rise in value.  They no longer offset, and diversified portfolios are becoming unhedged.  If and when the era of easy money ends, both stocks and bonds could fall, and perhaps precipitously.   

By unhedging diversified portfolios, the central banks are heightening investor risks.  Many wealthy and institutional investors, apparently sensing the danger, have been increasing their levels of cash.  But ordinary mom and pop 401(k) investors may not be able to shift gears so easily.  They may face increasing exposure, and perhaps not know it.  If they sustain losses when they expected to be hedged, they could lose confidence in the markets.  The result could be rapid and ugly.  That's what happened on Black Monday, October 19, 1987, when the stock market crashed and fell 22.61% in a single day because many institutional investors thought they'd be hedged by a financial product called portfolio insurance and found out unexpectedly that portfolio insurance didn't work. 

The central banks could reduce accommodative policies in order to raise rates and normalize the financial markets.  But that process could cause investor losses and trigger selling that leads to a market meltdown.  If, on the other hand, central banks keep printing money, they may worsen the problem.  You could shift more assets to cash (or at least refrain from committing fresh cash to the markets).  Otherwise, understand that diversification, like everything else in the financial markets, is starting to look a little hinky.

The Zen of Investing

How do you allocate your investment funds in times like these?  Stocks bound upwards for a couple of days when statistical data indicates the economy is slowing or a Fed governor smiles.  Then, the market nose dives crazily the next couple of days when oil prices rise or unemployment falls or another Fed governor frowns.  Bonds slump and then surge, or surge and then slump when inflation expectations rise or fall.  One constant in the financial markets is volatility.  Another is unpredictability.  And a third is no net gains--as in, for all the hysteria, stocks have hardly done squat this year.

The financial media is full of conflicting predictions--the market will boom, the market will crash--and conflicting advice--buy this, sell that, short the world and stock up on survivalist gear.  To paraphrase former Fed Chairman Ben Bernanke, things are unusually uncertain.

At times like this, the best option may be to step back from the chaos and cleanse your mind of desire.  At least, of desire for short term gains and avoidance of losses.  It's impossible to make money all the time, or to avoid all loss.  With entropy seemingly on the increase, any effort to make every day a good market day will have you believing six impossible things before breakfast and doing battle with windmills.

There's nothing wrong with holding cash, maybe even a lot of it.  Cash is beautiful.  A goodly amount in a federally insured bank account or U.S. Treasury debt promotes equanimity and sound sleep.  You will smile more.  There may be some who would argue that a fully invested, well-diversified, periodically rebalanced portfolio will provide better returns than a partially invested portfolio with a lot of cash.  This may be true in theory, but an awful lot of investors don't have the nerve to stay the course with a fully invested portfolio through the periodic mania of the markets.  They sell and freeze up, never again to invest, and potentially lose a great deal of future gains.  All the nice theory in the world doesn't amount to diddly if you're too stressed to implement the theory.  To maximize returns in real life, you have to be calm and unemotional.  And if doing that takes having bundle of greenbacks under the mattress, then so be it.  Don't feel the need to allocate every last dollar to something or other right away.  Hold off on betting your last buck until you feel comfortable.  Be zen, and increase your chances of becoming rich.

Artificial Intelligence in the Stock Markets

Artificial intelligence has been much in the news recently.  Well-recognized deep thinkers have propounded profound thoughts that predict good and bad outcomes for artificial intelligence as it becomes ever more of a reality.  The takeover of the world by machines is inevitable--with monstrous consequences--or not, depending on who you ask.

There isn't much real-world empirical data relevant to the opposing sides of this argument.  But one big clinical trial is underway:  in the stock markets.  Most of the trading done today in the stock markets consists of computerized trading.  Institutional investors, like mutual funds, pension funds, and so on, comprise most of the rest.  Mom and Pop, trying to invest a few nickels for their retirement, are like pedestrians surrounded by massive semis barreling along at interstate speeds.

Much of the computerized trading is done by dynamic computer programs.  In other words, the computer doesn't buy and sell based on a static algorithm embodied in the program coding.  The program can change itself in response to market conditions and activities.  In essence, depending on what the program detects is happening in the market, it can alter its own coding without the need for a human programmer to keypunch and proofread line after tedious line of code.  The details of how these dynamic programs work are generally shrouded in commercial secrecy.  But we have a situation where computer programs take note of what's going on in their working environments, think about how to change themselves to be more effective (i.e., profitable) in light of changing conditions, and then alter themselves to do better.  That's getting rather close to what people do: try to change and improve themselves in order to advance their careers or make more money in their professional activities.

We have seen in recent years how computerized trading can cause mini-crashes and other short term  turbulence in the stock markets.  Mom and Pop are often finding the waters too rough, and suddenly see the virtue in the paltry returns of passbook savings accounts or certificates of deposit whose yields have been flattened by the nearly supine yield curve.  Even some professional money managers are looking for ways to fly over or around the storm clouds of computerized trading, moving trading to venues that claim to allow only "natural" (non-computerized) investors to participate.

For academic researchers and other prognosticators, the dynamic computerized trading in the stock markets could furnish a useful body of data with which to work.  The rest of us, unwilling guinea pigs in a clinical trial we didn't sign up for, can only look to financial regulators and other government officials to ensure that the results of the experiment don't turn out too badly,

Easy Money: Reinvesting Dividends

Some of the easiest money comes from reinvesting dividends.  Over long periods of time (such as 20, 60, or 80 years) dividends accounted for a little more than 40% of total stock market returns.  Stated otherwise, if you spent dividends, as opposed to reinvesting them, your portfolio would have enjoyed only a little more than half the return it could have gotten with reinvested dividends.  Remember that reinvesting dividends has a compounding effect, and compounding is very, very good for your net worth (see http://blogger.uncleleosden.com/2009/09/if-you-love-compounding-compounding.html).  Your total return can be greatly magnified with compounding, accounting for well over half the long term return.

It's easy to reinvest dividends when you invest in mutual funds.  On the account opening form, just check the box for reinvesting dividends and interest, and the mutual fund's administrator will do the rest. Dividend reinvestment plans (DRIPs) offered by the company issuing the stock are clumsier, since you have register with the company and the shares are less liquid (not so easily sold).  Some brokerage firms will reinvest dividends received in your account.  However, you may not have from DRIPs or brokerage accounts the diversification that offers a reasonably steady flow of dividends.  The easiest way to reinvest dividends is through mutual funds (make sure you choose a fund with low costs).

You'll have to pay taxes on the dividends if they're held in a taxable account (although possibly at a lower rate than what you pay for ordinary income).  If your investments are in a tax-sheltered account like a 401(k) or IRA, dividends will be reinvested as a matter of course and you'll pay taxes when you withdraw the money, or convert or transfer to a Roth account.  For money from tax sheltered accounts, taxes will be assessed at ordinary income rates.  But taxes are imposed on dividends even if you don't reinvest.  So they're don't really affect your decision whether or not to reinvest.

Reinvesting makes money for you while you're sleeping, cooking dinner, playing golf, mowing the lawn or indulging in more screen time than you'd ever allow your kids.  Don't pass up this chance to make easy money. 

How To Reduce Volatility in Your Retirement Income

The S&P 500 has dropped three days in a row, and after all the market calm of recent months, many investors must be thinking that the apocalypse looms.  There are understandable explanations for the recent downdrafts.  Islamic radicals of the Sunni variety have rapidly seized several towns and cities in Iraq, along with American weapons and vehicles provided to the Iraqi government (and the administration worries about giving small arms to moderate Syrian rebels?).  Iranian paramilitary troops, who are Shiites, supposedly are fighting alongside Iraqi government troops to retake territory seized by the Sunni radicals. Is Iran now a more important ally of the Iraqi government than the U.S.?

Russian tanks have reportedly rolled into Ukraine, where the fighting is escalating.  Bashir Assad is winning in Syria, and the moderate rebels that the U.S. supports seem to be almost inconsequential.  Most of East Asia is squabbling over this island or that, with contending nations issuing many a proclamation declaiming a neighbor as a ratfink, a double ratfink or even a triple ratfink. 

Domestic politics also create uncertainty for the markets.  Eric Cantor, House Majority Leader, was just defenestrated in a primary election by a guy from far right field whose name, even if we mentioned it now, you probably wouldn't recognize.  (But we're going to, because it's Dave Brat, a marvelously fitting name for a guy who ousted the Majority Leader.)  Cantor, who outspent his opponent's six-figure campaign by $5 million, convincingly proved that money isn't everything.  Not even in politics.  The Koch brothers must be scratching their heads about what checks to write next.

The markets will always be plagued by volatility.  And it tends to pop up when you least expect it.  That might be inherent in the definition of volatility, but you know what we mean.  Yogurt happens, but you don't want your retirement finances smeared with yogurt.  While there are no complete protections against the ups and downs of life, here are a few ideas for calming the financial waves.

Build Up Social Security Benefits.  Disregard the hyperbole.  Social Security will be there when you retire.  Maybe not exactly as it is now, but nevertheless in a meaningful form.  Any politician who votes to eliminate or sharply reduce Social Security retirement benefits will end up doing an Eric Cantor faster than Eric Cantor as voters reject the idea that they should have to eat dog food in their old age.  Work as long as you can to build up your benefits.

Get a Pension.  If you're lucky enough to get a pension, stick out it long enough in that job to qualify.  Although classic defined benefits pensions are usually found these days only alongside the remains of diplodocus, lasso one if you can.  Other pension arrangements, like cash balance plans, are a lot better than no pension. 

Save More.  Saving more is a salve for portfolio instability and financial insecurity.  Those that have the saving jones won't have to get loans.

Use Retirement Accounts.  Retirement accounts like 401(k)s, IRAs and so on offer tax advantages that let you leverage your retirement savings, while limiting your ability to prematurely spend your savings.  A particular advantage to a 401(k) account comes if your employer provides a matching contribution, which is the freest money most people can get.  Use these accounts as much as you can.

Diversity Your Investments.  The values of all assets wax and wane.  But they usually don't wax and wane in unison.  More commonly, some assets get yeasty while others do the fallen souffle thing.  And vice versa.  So a diversified portfolio is usually kind to your antacid budget.  There are moments, like the 2008-09 financial crisis, when it seems like almost all assets belly flop.  But these cognitively dissonant interludes are the exception and not the rule. 

Consider an Annuity.  A fixed annuity (one that pays a specified dollar amount per month) or a fixed annuity adjusted for inflation can be a reasonable way to provide a steady income.  Annuities aren't cheap, and you should buy only from an insurance company with a strong credit rating. Don't put more than about one-third to one-half of your portfolio into an annuity because cash needs in old age can be unpredictable and it helps to have a nice pool of cash or cash equivalents.  Be very cautious about variable annuities--they often have high expenses, and the point here is to reduce volatility, not subject yourself to it in another form. 

Health Insurance and Long Term Care Insurance.  Financial volatility can sometimes come from sudden increases in expenses, and not just decreases in portfolio values.  Health care and long term care needs are the biggest landmines in the journey through retirement.  Most retirees are covered by Medicare, but if you're not, then buy something else.  The Affordable Care Act, despite all the teeth-gnashing on the right, is likely to be a good option if you don't have anything else.  If you have a significant net worth, consider buying long term care insurance, especially if you have a spouse who may depend on that net worth after you've gone to the great Dance Party in the sky.  It's expensive, but so is long term care.  If you want more than the quality of care given to Medicaid patients, long term care insurance may be a good choice.

Part-time Work.  Okay, you want to hear about retirement, not employment.  But part-time employment reduces the extent you need to draw down your savings, so you can keep more powder dry for later.  It also lessens your risk of dying from the boredom of day time TV.  It may boost your Social Security benefits (depending on your work history).  And the dignity of work is better than the indignity of looking for sales on dog food.

The Lucky, Lucky Fed

Soldiers want their generals to be lucky.  As capable and knowledgeable as generals may be, they still need luck to win.  And citizens want their central banks to be lucky, because central bankers often fail even if they are capable and knowledgeable.

The Federal Reserve has been very, very lucky.  Unrest in Ukraine, territorial disputes in East Asia, the usual morass in the Middle East, and now nationalist parties winning European elections, have all combined to push U.S. Treasury yields down even as the Fed steadily withdraws its quantitative easing.  Financial markets mavens who confidently predicted that this would be the year of rising interest rates and falling stock prices have had to substitute excuses and explanations for predictions. 

Some still persist in forecasting rising rates and falling stocks.  Perhaps they will be proven correct.  But if you're betting your money on these predictions, remember that you're, at least in part, betting on the Fed's luck running out.  A bet on bad luck is still a bet on luck.  If you wouldn't play the lottery or patronize a casino, why bet on (or against) the central bank's luck?  The smart thing to do is stay diversified, and be patient.  (See http://blogger.uncleleosden.com/2014/05/why-you-should-invest-like-smart-money.html.)  The tortoise tends to be a better investor than the hare.

Why You Should Invest Like the Smart Money

One characteristic of the investing strategies of the wealthy is to diversify.  Stocks, bonds, money markets, real estate, alternative investments, collectibles, precious metals, jewelry, and so on are frequently found in the portfolios of the high net worth crowd.  Diversifying is a way to win no matter what's going on with asset values, and the wealthy want to stay wealthy.

The 99% should do no different, and recent market activity illustrates why.  Bond values have improbably risen in recent weeks, while stocks are stuck in a trading range right about where they started the year.  Gold and silver went up earlier this year, but have slid back.  Real estate ended 2013 with a roaring comeback, but now seems to have stalled out in many markets.  International markets have delinked, with Asian markets generally falling over the past six months, while European markets have moved up slightly (Ukraine crisis notwithstanding).  It would not have been easy to predict this mix of events.  Indeed, it's rare to find financial analysts who predict much of anything right.  Few predicted the 2007-08 financial crisis.  Few predicted the 30% jump in stocks in 2013.  Few predicted that bonds would rise this year.

The investing patterns of the smart money reveal that the smart move is to diversify.  Don't look for a quick buck.  You'll probably get a quick loss.  Don't look to hit a home run with a single investment.  The financial press may glamorize the few who manage to do that, but generally pays little attention to the many who fail.  Don't try to predict the unpredictable.  There are rare situations, like 2008-09, when all asset classes seem to be falling in value.  That's what can happen when vast amounts of debt and other leverage enter the financial system in one-sided bets dependent on rising asset values.  When that debt begins to lose value, the assets it was used to buy are at serious risk.  But more typical is what we have today--a lot of uncertainty, but some of the uncertainty is about the upside and some about the downside.  Most of the time, diversification is the best way to play your cards. 

And if you're still unhappy about your net worth, save more.  Whether the markets are doing well or badly, adding to your pool of capital will pay off in the long run.

Questions About Bitcoin

The hype about Bitcoins is reminiscent of some of the early hype about the Internet.  Long, long ago, in the Paleolithic times of 20 years ago, the Internet was seen as an idyllic world where all would be equal and a person could accomplish anything with a computer and just a little effort.  The wide open nature of the Net allowed anyone, however anonymous and humble, to speak out and be heard, create and be seen, reach out and touch untold millions, all with just a few keystrokes.  Wondrous things would happen; lead would be turned into gold; a veritable digital Eden would arise and everyone who entered would attain nirvana.

Well, it didn't quite work out that way.  Gigantic corporations now dominate the Internet, and powerful government agencies lurk in the background, spying high and low, leaving no server unmolested.  Bad people from around the world seek to victimize, defraud and destroy; and the wide open nature of the Net allows them to do so with just a few keystrokes.  The free-standing individual who was supposed to have been the pillar of the digital community has shrunk into an online sheep, waiting helplessly to be fleeced of all personal information, browsing habits, bank funds, and credit lines.

The Norman Rockwellian narrative of Bitcoins would have us believe that they are a pure form of value, unmarred by the pock marks of central bank policy.  "Mined" by solving mathematical problems, transacted anonymously on a peer-to-peer basis, Bitcoins would be finite in amount and invulnerable to inflation since no one, supposedly, would control them.  Those who held Bitcoins would be liberated from the oppression of governments and the highway robbery of fee-charging financial institutions that handle transactions in fiat currencies.  A brave new monetary system would supersede the corrupt, degenerative fiat currencies of yore, the clouds would part and the sun would shine forever.

But reality is turning out to be blemished.  It seems that the use of Bitcoins for payment made an online market for illegal drugs called Silk Road attractive to denizens of dark corners of the Net.  The anonymity of Bitcoin transactions is a godsend for scoundrels and knaves of every variety, with government crime fighters largely unable to figure out who to put on the Ten Most Wanted List.  It's now clear that Bitcoins will attract criminals, organized criminals, terrorists, tax evaders, and other miscreants with something to hide.

But, are there bigger monsters lurking in the shadows?  Rogue nations, which may be facing sanctions in financial systems denominated in fiat currencies, might find Bitcoins a convenient way to get back in business.  And business could be nefarious indeed, with weapons, equipment for processing radioactive materials, drugs, and other suspect cargo changing hands.  Intelligence services--foreign and domestic--would have many reasons to use Bitcoins.  Undercover operatives need to be funded.  Bribes need to be paid.  Deniability would be enhanced.  Detectability--and accountability--would be reduced. 

Then, there's the market for Bitcoins.  Unregulated and opaque, it's ideal for manipulators and fraudsters.  The mining process is getting harder and harder, as the mathematical problems that need to be solved become increasingly difficult.  More and more computing power is needed to solve them.  That means bigger, more complex and more expensive computers must be used. The advantage goes to those that are well-capitalized.  Yet the price of Bitcoins is notoriously volatile.  Who can afford to invest in the massive computing power that it now takes to operate a successful mining operation while withstanding the wild price swings in Bitcoin prices?  Wealthy speculators, rogue nations, organized crime, and financiers operating from secrecy jurisdictions might all see an opportunity to make a fast Bitcoin or two--or maybe a lot more--off of the naive true believers who buy and transact at the retail level.  Trading anonymously, these big boys could bid prices up using multiple accounts they control to trade back and forth with themselves.  They could pay for online ads hyping Bitcoins as they walk the price up, provoking an investment frenzy among the sheep.  Then, as the price reaches meteoric levels, they dump the coins that they've mined, and then walk away, leaving the price to move whichever way it will (which is likely to be down). 

The biggest potential problem for Bitcoins may well be that the big players will move in.  And, as with the Internet, the little people will suffer.  Invest at your peril.

Barack Obama's Curious Redistribution Ideas

President Obama recently spoke critically of the gap between the rich and the poor.  He has endorsed an increase in the federal minimum wage, from $7.25 up to $10.10.  He has argued for stronger enforcement of the labor laws.  He seeks universal pre-school.

Predictably, Republicans stood in opposition.  More government spending isn't the answer, they contend.  Economic growth is the tide that will lift all boats, they say.

Republicans, whether they are right or wrong, have nothing to worry about.  Barack Obama, whatever he may say, isn't really serious about changing the distribution of income or wealth.  He favors reducing the cost of living adjustment for the Social Security, military and federal retirement benefits that tens of millions of Americans depend on.  Cutting back on retirement benefits worsens the distribution of income and wealth.

There were some federal tax increases that took effect this year.  But the income tax increase on high level earners was accompanied by an increase in Social Security taxes (which are regressive).  So what was the net effect?  Most likely, very little or no redistribution.

The Affordable Care Act would have a redistributive effect because of its health insurance subsidies for low income participants.  If only people could enroll  . . . .

Barack Obama has serious credibility issues.  He drew a line in the dust over the use of poison gas, and Assad stepped over it.  Obama squirmed, complained, and then let the Russians broker a deal.  He didn't have the management skills to implement his signature legislative achievement, the Affordable Care Act.  He negotiated some sort of deal on nukes with Iran, although that deal seems to have implementation issues as well.  As negotiators talk, Iran continues to enrich.  If you're looking for action from the White House on redistribution of income or wealth, don't hold your breath.  Keep saving and investing, because you're on your own.