May 20, 2022Money Financial literacy Economy In the news
What's Happening Today
I’m back in action after welcoming the arrival of our healthy baby girl and taking care of an exhausted, but otherwise healthy, wife. I’m here to take on the all-important task of sending out the “What’s Happening Today!”
Despite the last two weeks showing some volatility, the market has closed in on its second positive day in a row this week. You may have heard the cliché of a down market being “the only sale in town that folks will run away from”?
I’m going to attempt to put that in perspective…
The stock market is a shopping mall; a shopping mall for buying businesses. You can buy a partial ownership stake in pretty much any publicly traded company you like, and you are issued shares as proof of ownership.
A business makes $1/year in revenue. During the times when money is flowing freely, and people are feeling good about the economy, investors might be willing to pay something like $30 for that $1/year in revenue. The opposite happens when there are negative factors like job loss or global unrest. Investors may only want to pay $8 or $10 for that same business. But it will never go to zero for that business.
That means you’re getting a revenue-generating business for free, and no matter what is happening in the world or the economy, no one is giving away free money. Not ever. Still, prices that range from upwards of $30 to the low end of $8 or $10, will still create volatility. This is why we see significant downturns in the stock market as investors move from hyper optimistic to hyper pessimistic. But year over year, decade over decade, good business, and in general, capitalism and our love for consumerism, will see profits increase over time. So that $1/year becomes $2/year becomes $3/year, and then even on the low end of the economic cycle where investors are only willing to pay $10 for every dollar of revenue – that’s still a price of $30 – and perhaps would even go for $60 when things are good. And more importantly, way above what we paid years ago.
Yes, not all companies are profitable. Fortunately, you have advisors and analysts working tirelessly to help ensure the companies that we do recommend are profitable or the funds we buy own these profitable companies!
Maybe you’re not into volatility. To reduce those wild swings, we use other assets; other assets that have proven over time to be negatively correlated to the stock market. The main one is debt, where a company, government, or even a local municipality doesn’t want to give up an ownership stake, but is still needing some money, and is willing to pay interest on a loan. The riskier the company, the more interest you receive. These are called Bonds and they fall under an asset class called “Fixed Income.” The typically safer stuff. These investments are not meant to increase in value but are meant to pay the investors a fixed amount of income for a specific period of time. However, interest rates do affect the market value of these bonds because of course, there’s a market for bonds. In fact, it’s a much larger market than the stock market.
A bond that is paying 2% interest should be worth less than a bond from the same issuer paying 3% interest, so in a rising rate environment, the market value of these lower-paying bonds is reduced as those same issuers are forced to pay higher interest on new bonds. We generally don’t use individual bonds. We use collections of bonds that are actively bought and sold behind the scenes so that even though the market value of these groups of bonds is lower (the lowest in 40 years, I might add!), we are getting paid higher interest rates. As interest rates peak and start to fall back the other way, the market value of these funds will increase and provide a nice hedge against future volatility.
Mike is away until Tuesday, but please feel free to reach out anytime to chat!