Thoughts on Current Market Events: Emerging Markets & Stimulus Wind Down

As sexy as "stimulus" sounds, investors are starting to worry what impact the pulling back of quantitative easing (the Fed's way of stimulating the economy by keeping interest rates low) will have on the markets, both in the U.S. and abroad. Easing up on stimulus should be a good thing, a sign that the economy is doing better, that the unemployment rate is improving, that roses are starting to sprout, and the sun is beginning to shine. But, of course, for every action, there is an equal and opposite reaction (thanks, Mr. Newton), so fears abound.

Pulling back on quantitative easing will likely mean an increase in interest rates here in the U.S. Generally, when Treasury rates rise, other interest rates, including mortgage loans and credit cards, go up, too. Part of the fear here is that the U.S. economy is still fragile. For example, while the unemployment rate has fallen to 6.6%, millions of people have been unemployed for so long that they have stopped looking for work; they are not included in that 6.6%. All told, the labor participation rate is only 63%, according to the Washington Post, the lowest it's been in a generation. Home sales are volatile at best. Consumer spending has been on the rise, but is nowhere near what it was pre-recession. The American middle class is slowly dwindling, which is displayed most simply in the consumer sector, where high-end luxury brands such as Kate Spade and Michael Kors, and low-end retailers like Dollar Tree, are vastly outperforming middle-of-the-roads like Abercrombie & Fitch.   

If interest rates rise too quickly, it could send the U.S. economy into a downward spiral. Credit card interest rates are already high, so consumers could be crippled by higher rates. High gas prices will only compound this effect. High food and health care costs would only make things worse.

Globally, the effect of relieving QE was witnessed recently. When the Fed announced its confidence in the U.S., investors fled emerging markets and ran straight into the arms of U.S. Treasuries. The run-up in the U.S. stock market over the past few years has taken a toll on emerging markets. EM stocks lost 5% in 2013, according to MSCI. EM sovereign debt performed similarly poorly. Leaders abroad have expressed concern about what continued easing will do to their countries' currencies, exports, and inflation levels. 

I like to think of myself as a contrarian investor, as following the crowd rarely leads one to buy low and sell high. That said, I think it's a great time to invest in emerging markets equities while prices are low relative to U.S. stocks. Keep in mind that, as quantitative easing is unwound more and more, EM stocks will likely get more volatile. In the end, I think it will be worth the wait. I'm of the belief that developing countries will not be wiped off the map, that they will continue to grow as time passes. 

I've expressed in previous posts that I don't think the record U.S. stock market levels are sustainable, as they do not reflect the true underlying health (or lack thereof) of the economy. (In fact, the S&P 500 just reached a new high today of 1,853.38.) I expect that they will come down as QE ends. Over time, investments in emerging markets may set off U.S. and other developed markets' losses. 

Shutdown that Debt Ceiling!

Dear Readers,
It's been over a month since I wrote a post -- what a crazy month! I've had several job interviews, so I've been crazy busy preparing for those, and I'm making great strides on the creative writing project I'm working on. That being said, what a crazy time in the markets this past month! Actually, I should state that more accurately: what a crazy time in the government this past month!

The U.S. government officially shut down on Tuesday, October 1 since Congress and the White House couldn't come to an impasse on funding Obamacare (which has already been made a law and been defended by the Supreme Court). This means that a lot of services are not available, national parks are closed, and, most unfortunately, some people are not getting the public assistance they rely on.

The shutdown is a big deal, but the market didn't really react to it, implying that investors don't really think it's a big deal. Consensus seems to be that it's about the egos of the leaders of the Republican party, primarily. I agree with that on one hand; however, the country is not run by Republicans alone, so Democrats are not innocent in this debacle. But, politically, the fallout appears to have wounded the reputation Republicans much more -- it's approval rating is at just 28%, the lowest in the history of Gallup polling (which, to be honest, isn't all that long; they've only been polling this for 21 years). This could certainly favor Democrats in the next round of elections, but that's over a year away. It could have the most positive impact on the Democratic presidential candidate. Favorable buzz is already beginning to swarm around Hilary Rodham Clinton for her possible run in 2016.

But back to the markets. As I said, the markets didn't even flinch at the shutdown. BUT it freaked out at the possibility of the U.S. hitting the debt ceiling and defaulting on its obligations. Default means that interest rates will rise rapidly because, suddenly, the U.S. has become riskier and investors demand to be compensated for risk.

The rest of the world is on edge about how the U.S. will resolve this issue because U.S. Treasury rates effect so many other rates around the world, and many holders of Treasuries live outside of the U.S. Actually, the Chinese government is the largest U.S. creditor, holding $1.3 trillion of Treasuries. As a result, officials in Beijing have stressed, like a mother of arguing siblings, that the U.S. had better figure itself out sooner rather than later.

Congress and the White House have only 3 days, until October 17, to come to a consensus. Needless to say, political agendas should not put the world markets in jeopardy. Now, the world waits to see who will be the bigger person in government.

'Tis the Season

As investors grow more familiar with the companies in their portfolios, there's a few times a year that build near Christmas-like anticipation: earnings season.

Companies typically report their earnings quarterly. Since they have to get their financial statements audited, checked, and re-checked, there's a slight lag between the end of the quarter (generally the last day of the months of March, June, September, and December) and when earnings are actually reported, so they typically are announced in April, July, October, and January. This is not to say that all companies report during these periods; companies can make up their own fiscal quarters and years if they wish.

Public company earnings are reported, well, publicly. The company CEO or other top management will hold a conference call with investment bankers and institutional investors, and tell them everything the company sold and earned during the quarter. Bankers and investors can ask questions on the call, which can get intense if the company delivers bad news. Retail investors like yourselves can listen to these calls as well, as they might linked to the company's stock listing on Google Finance.

Traditionally, Alcoa, the aluminum producer, is the first company to report, kicking off earnings season for public companies. Investment analysts cling to the company's every word, as they believe that a pattern in Alcoa's reporting may be repeated by other companies, even if they're in a different industry. For example, if Alcoa's earnings go down, and the decline is related to a slowing in construction of homes, analysts can extrapolate that other parts of the economy might slow down, too, from related industries like home improvement retailers (such as Home Depot) or seemingly unrelated ones like PepsiCo (can't forget what sodas come in!).

To that end, earnings season also gives investors an idea of the condition of the overall economy. If companies' earnings are falling across the board, it is likely a sign that consumers are not spending, probably because they can't afford to. If earnings are growing, then the economy is likely on a good curve, going up.

Investors also use a company's earnings announcements to try to predict what's to come in the company's future. For example, Apple's third quarter earnings were announced last week, on July 23. (Click here if you don't have Wall Street Journal access.) The company announced that sales of the iPhone had grown 20% over the past year, but iPad sales dropped 14%. Revenue was basically flat and profits declined 22%. From this information, investors might gather that Apple -- historically an extremely innovative company -- may be losing its edge, especially to competitors like Samsung. Investors show displeasure with earnings results by selling the company's stock, but they didn't sell off Apple very much, showing that they still believe the company can recover.

One thing to note during earnings reports is source, and quality, of earnings. The best reports come from increases in revenues, which lead to increases in net income (profit, or earnings). What we're seeing now overall is companies whose revenues are staying the same, but profits are increasing. This is still good, but could be better. The increase in profits here is coming from decreases in expenses; companies may be cutting back on spending on supplies or even salaries (layoffs!) to save money. This will result in an increase in earnings, but investors want to see growth, not just cost cutting.

While it's not good to obsess or make snap judgments based on one earning's report, I believe that retail investors should pay attention to these announcements and listen to the calls, if possible. If anything, they're a great way to learn more about the company, the closest to an insider's view many of us will ever get. But remember to keep the big picture in the mind: what's going on with the company's competitors? What's going on with the overall economy? In times like these, those questions -- especially the latter -- matter more than anything.

"Invest in us...Because you're worth it": Alternative Investments

Given the Security and Exchange Commission’s ruling this week that allows hedge funds and the like to advertise publicly, I can’t think of a better time to shine some light on what are known as alternative investments.

Alternative investments are called that because, well, they are alternatives to investing in regular stocks and bonds. Some of the most popular alternative investments include hedge funds, private equity funds, and venture capital funds.

Hedge funds are basically mutual funds for the ridiculously wealthy. A hedge fund pools money from different people or institutions, and invests in stocks on their behalf, but the fund doesn’t typically invest the way a mutual fund would. A hedge fund will invest in derivatives or sell stocks short, for example.

Private equity funds are similar to hedge funds in that they pool money from wealthy people and institutions, but these funds don’t buy or sell stocks that trade on the public markets. They buy whole businesses, sometimes by buying that company’s stock (which is known as “going private”) or buying it from its previous owners. Private equity funds generally invest in businesses with the intention of making them more efficient; after several years, the fund usually sells the company again, hopefully for a significant profit.

Private equity was talked about which a lot during the 2012 U.S. presidential election, as one of the candidates used to work for a large PE firm. Commercials featuring disgruntled employees he had “fired” from the companies riddled the airwaves. My personal opinion is that the attacks on the PE industry were unfounded and the candidate’s work was taken out of context. Rest assured that PE is not evil; it is very complex, but it is not bad.

Finally, there’s venture capital. If you watch the ABC show Shark Tank, you’re already familiar with the concept. Venture capital also pools money from wealthy investors, but these funds invest in companies that are babies, also known as start-ups. VC, as it’s known, is widely considered the riskiest of alternatives because the investments are in companies that are so unsure; many have not even made a profit yet. But the upside is that you can help an entrepreneur fulfill a lifelong dream that may be the next Google or Facebook.

All of these investments could potentially make you A LOT of money. But you know the drill: with high reward comes high risk. These investments are certainly more risky than buying Treasuries, and are generally more risky than investing in a stock index fund. BUT, there are a few other stipulations that make these investments even more out of reach:

• The minimum investment for these funds is typically $250,000 to $1 million, sometimes more.
• The fund managers generally get a 20% cut of the profit AND you have to pay about 2% per year to help them run the fund.
• Only “accredited” investors can play in the sandbox anyway.

That being said, if you start to see ads for alternative investments, most of us can only do just that: watch. But for those who could afford to play, be cautious, as with any investment, and know what you’re getting yourself into.

Guess I shoulda bought a house last week

Dear Readers,
It's been a while since I've written and a lot has gone on in both my life and the markets! On my end, I graduated from business school, packed up my apt in DC, and moved my whole life to New York City. I've gotten settled in well, exploring the city almost every day. I say "almost" because my job search is in full force, and looking for a job can be a full-time one, ironically. But, I'm back to blogging, so here goes!

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So much has happened in the markets over the past month, but much of it has occurred in the past week or so. You probably saw headlines to the effect of, "Markets Flinch as Fed Eyes Easy-Money End," or "Global Sell-off Shows Fed Reach Beyond the U.S."

What happened to cause all of this drama?

At a meeting of the Federal Reserve Board, Chairman Ben Bernanke basically said that he is considering ending quantitative easing (the buying up Treasury bonds by the Fed itself to keep interest rates low so people spend and invest more) later this year or at some point next year, rather than waiting until the unemployment rate was below 6.5%, as he initially promised. This implies that Bernanke feels that the U.S. economy is strengthening at a pace that it won't need to be supported by the government anymore; it's a compliment, really.

Problem is, the market did not interpret it as such.

Investors around the world freaked out, selling stocks and bonds like nobody's business, which shows that investors are not as confident in the strength of the U.S. economy as Mr. Bernanke is. It also shows that investors, businesses, and consumers alike have all gotten very used to record low interest rates. (For example, car sales have jumped exponentially over the past year.)

The trouble is, QE has to end at some point. And with that, interest rates will rise. The big sell-off in bonds last week helped them rise already. The yield on 10-year Treasuries jumped to 2.308%, its highest level since March 2012. The yield on 30-year Treasuries rose to 3.65%, a height not seen since 2011. Even more amazingly, these rates went up faster than they have since August 2009.

So, what does that mean for the average individual, even someone who is not an investor?

Treasury yields are used as a base for many interest rates, from savings accounts to car loans to mortgages. With yields being so fickle last week, mortgage rates have shot up. As of June 27, 2013, the rate on 30-year fixed mortgages were 4.46%, the highest since August 2011. BUT, last week, said rate was just 3.93%.

This is really significant because, of course, the interest rate has a massive effect on the size of a mortgage payment. Think of it this way (courtesy of CBS News):

"A $165,000 30-year loan obtained with last week's 3.93 rate will cost $786 per month. Under the new 4.46 percent rate, that jumps to $832 per month. That's a $46 monthly increase -- or a whopping $16,560 over the life of the loan. ...For a $300,000 30-year loan, the rate increase comes to an extra $92 per month, or $33,120 extra over the life of the loan..."

YOWZA!

Unfortunately, there's not much that individual home (or car or appliance) buyers can do. Never try to time the market, of course. Just wish for the best and refinance as appropriate, although the odds of rates doing down from where they are now are extremely slim, in my opinion.

Thoughts on Current Market Events

So, you might have seen the headline last week: “Markets Soar to New Highs.” Or, “Job Gains Calm Slump Worries.”

The Dow Jones Industrial Average, the index that tracks the 30 largest companies in the US, hit an all-time high, above 15,000, on Friday, as did the S&P 500, which flew to over 1,600 points. (Think of “points” as the price per share of this exact index, which is very different from that of a fund or ETF that reflects the index.)

Ordinarily, this would be time for great rejoicing. If you have an index fund, it is likely performing extraordinarily well and you have no complaints at all. Companies’ earnings reports have been generally positive, although many companies are missing analysts’ estimates. 

So what’s the big deal? 

A) The big deal is the big picture: although unemployment has been falling, it is still 7.6%, which is higher than the targeted 6.5% and much higher than the historical average of 5.8% (the historical average is only this high because it is taking the past five years into account, when the rate reached over 10%). 

U.S. Treasury yields are still at near-historical lows, with the 30-year bond – traditionally the highest yielding – at 2.98%. Some blame quantitative easing for keeping these yields so low. Quantitative easing involves the Federal Reserve buying U.S. Treasuries, with the purpose of keeping yields low so it is cheaper for companies (and individuals) to borrow money to buy houses, cars, etc. The central bank began QE in 2009 and has said that it would stop when the unemployment rate reached 6.5%. 

As a result, investors who would typically rely on Treasuries for yield have not been able to make the money they sought to with yields as low as they are. So, they began buying stocks. And more stocks. And more stocks. And even more stocks, pushing the price up to 15,000 and 1,600 for the DJIA and S&P, respectively. 

Some investors are now nervous because they think the market is overbought and overvalued. Well, the S&P 500’s historical price-earnings ratio is about 15. Right now, it’s nearly 19. So, yes, the market may be a little overvalued. 

B)      Another explanation for the recent surge is that investors are anticipating stronger growth in the U.S. economy quite soon. One way that stock prices are determined is by calculating the present value of a company’s future earnings. One could say that the U.S. economy’s future earnings look so great right now that the high market price is deserved. Optimism!

I’m inclined to go with option A, based on my education. Although I am very optimistic about the outlook of the U.S. economy, I think sending the market to new highs on an uncertain foundation is not sound. I would advise my friends to hold off on stock purchases until the market cools down. However, I’m no Miss Cleo and I could be wrong (actually, that would make me a Miss Cleo, haha!).

Investing Insights from China

I'm back from the trip of a lifetime in China. While it was an interesting experience for many reasons (primarily because I'm African-American and was quite the spectacle, apparently), I learned ton more about how business is done in China and I know understand much more why investors get so jazzed about sending money to the East.

Upon arrival in Shanghai, I was greeted by this huge Coach ad, right outside my hotel window:

 

It is a country of both extreme wealth and extreme poverty, but investors have jumped on the former as a money-making opportunity. The Chinese middle class is burgeoning and, like Western countries, this means that the population is consuming more luxury goods. I saw an impressive number of Coach, Tiffany, and Louis Vuitton stores in Shanghai alone.

 

But, before you march off to buy shares, note one thing. Many purchases of luxury goods in China were the result of a business and government culture of gifting. Some might call it "bribing," but I think that's too strong a term. Business partners exchange gifts after a deal is closed as a way to thank each other for doing the transaction. Following my team's presentation, we gave our company representatives small tokens of our appreciation, and the they did the same for us. Of course this can lead to many abuses, especially bribing. To that end, the Chinese government is cracking down on this type of corruption. Unfortunately, this may take an unforseen toll on luxury brands in China. A new government was inaugurated only in the last few weeks, so only time will tell what will actually happen. But investors in luxury goods companies who are relying on growth in China should beware.

 

Another thing to note is the major housing boom in the big cities, especially Shanghai, Beijing, and Xi'an. China is the world's most populous country with 1.36 billion people, and all of those people need to live somewhere. However, I was taken aback at the rapid real estate development. It seemed to me that houses (well, apartments, mostly, as result of high population density) were being built long before demand could fill them. This could also play a role in the future on the incomes of the Chinese middle class. If housing values fall, so will their net worths and ability to spend on luxury items. The Communist government can likely keep some damage from occuring if there is a bubble burst like that of the US in 2007. But I would caution investors to be careful of a situation that appears to be growing more precarious.

 

 

 

It's not all bad news, of course! I saw a lot of growth potential in China, particularly in terms of infrastructure. As they continue to build homes, they will need roads, electricity, and public transportation. There is also a bit of a pollution problem that will have to be tackled. Investors can take advantage of these things by putting money toward building out these roads and investing in companies that will put electrical wires underground. Some of my classmates also joked that, once it becomes required to wear a bike helmet, helmet makers will clean up!

 

 

 

Some people say that China is "out," as if it were culottes or harem pants. The world's largest nation definitely has opporunities, but I would shake things up a bit by looking at Brazil or India, or in even riskier frontier markets, such as Mexico. Next week, I'll explore how one would invest in emerging markets.

 

My Conversation with the CEO of Michael Kors / Breaking Up is Hard to Do

Those who follow me on Twitter know how excited I was about John Idol, CEO of Michael Kors, speaking at my university last week. It was a great talk and I fell more in love with the brand by the end of it. But I still couldn't shake the question that's been gnawing at me for the past several months.

So I asked John during the Q&A (after thanking him, on behalf of my stock portfolio, for going public): "How do you respond to equity analysts who say you're growing too fast? Your PE is at 45, and Coach's is 12. What do you say when they ask if this growth rate is sustainable?"

"Great question," he said. Then he squinted and asked, "Is that a Michael Kors watch?"

Yes, it was. :)

His answer to my question was that Michael Kors is filling the "white space" of accessible luxury wherever it can. They will cap the number of stores at certain number, but the company does not want to keep itself from going to places where it could succeed. They don't think about price-earnings ratios, he said; they think about where they can fill a void.

I was somewhat satisfied with his response. In particular, I was comforted that they will set some limits on the growth, but not impede it. However, given yesterday's earnings report of 70% revenue growth, I still wonder if MK is just a really hot trend that can fall out of fashion at any moment.

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This leads me to an important, but painful topic: when do you sell a stock?

I have many stories about selling stocks at the wrong time. Hopefully, I've learned my lesson and can share with you my mistakes, so you don't make them.

There are 3 main reasons to sell a stock: a change in price, a change in the company, or a change in your situation.

A change in price: 
When a stock has hit your target price, it may be time to say good-bye. The target price is the share price at which you say, "There is no way this stock is going to go higher." While you can rarely ever be certain of this, it is always a good idea to have a certain target in mind. This tempers your expectations: you'll patiently wait for the price to go up and/or you'll sell at a high price instead of a low one.

You may have heard the phrase, "Buy low, sell high." It's an investing commandment that every investor sins against. TRY TO FOLLOW IT. Don't get emotionally attached to a stock and believe that if it falls and keeps falling, it will go back up. It might, but there's no way of guaranteeing, so get out while you can while it's hot.

The downside to selling high is that you may miss any additional upside, or share price increases. Well, better safe than sorry, I say. It's better to collect something than to collect losses.

A change in the company:
You'll likely want to sell a stock when the company's finances have deteriorated. If revenues and profits are falling, and expenses and debt are increasing, it does not paint a nice picture for investors.

Take Avon, for example. Although it is a classic, iconic brand, the company has not been able to perpetuate its business model (door-to-door salesladies) in the age of the Internet. This has taken a toll on Avon's revenues and profits. It has mounted up quite a bit of debt as it tries to survive. The company's stock price has reflected its troubles in recent years: even well before the 2008/09 market crash, Avon's stock traded on average between $35 and $40 per share. Now it bearly reaches $20.

In addition to slacking financial fundamentals, other reasons to consider selling a stock could be:

• The company is going in a different direction, perhaps one that doesn't make sense given what the company is good at.
• It could have gotten new leadership that doesn't inspire quite like the old leadership (I'm afraid Apple might become the next example of this).
• It has cut its dividend, which is a sign it could be going through financial trouble.

A change in your situation:
Your decision to sell a stock could come from your own situation. For example, let's say you think another company's stock is worth buying, but you can't afford to own them both. If you believe the new stock will perform better, it might be worth tossing the old one.

Also, stocks are extremely liquid, which means that they can be sold easily. So, if you need cash in pinch, you can always sell your stock without penalties. However...

The tax implications may not be worth it.

When you sell a stock at a higher price than what you paid for it, you have to pay what's called a capital gains tax, which is generally 15% of the gain. This automatically decreases the return you actually recieve. And don't forget that you have to pay commission on the sale to your broker!

Basically, selling a stock can be very expensive, so make sure you are SURE that you want to do it before you go through with it.

I bought 10 shares of Michael Kors for about $33/share on February 2, 2012, just a couple of months after it had gone public. On Valentine's Day, the price jumped to $42/share, after a great earnings report. The price lingered between $39 and $42 for a couple of weeks, and in early March, I sold all 10 shares for $43. I'd made about $100, so I was happy.

Sadly, the price kept going up, and I got antsy. So I dove back in. For $48. I could only afford 5 shares this time. So not only did I buy the shares at a much higher price, I couldn't even own anywhere near as many. :(

The upside to this story is that I still own the 5 shares, and as of yesterday, they bounced to $63/share. While I do believe Michael Kors is growing too quickly now (the PE jumped to 50 after yesterday's 70% revenue growth announcement), I believe in the long-term potential of the brand, so I plan to hold on for years to come, unless something tells me otherwise.

Ultimately, you should strive to be an "investor," or someone who holds stocks for a least a year, not a "trader," someone who holds them for less than a year. It is important to remember that value comes with time, so be patient and leave your emotions at the door.

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Next week, we'll talk diversity. A diverse world is a safe world. At least for your stock portfolio.