- Energy: Oil & Alternatives
- Government Spending
- Real Estate
- Negative Yields
In our January newsletter, we said that we expected this year will be a re-opening of the economy opportunity. We expected as vaccines rolled out, that this summer would see a resurgence in travel and entertainment (the have more fun trade). Personal travel is already picking up with air and cruise reservations at all-time highs (cruise) or close (air). Business travel will certainly make a strong comeback in the second half of this year. Even businesses who think they will only use internet meetings will find they need to see prospects and customers face-to-face, once their competition does.
About 110,000 restaurants, or 17%, have permanently closed. Certainly, over the next few years, many or most of those will re-open under new ownership, but this reduction in competition will be a two-year advantage for those who survived. The fast-food chains remained open, so their stock prices already reflect the advantage they’ve enjoyed. It is the casual and fine-dining restaurants we have focused on for investment.
This is also true of the hotels and the REITs (Real Estate Investment Trusts), theme parks, entertainment venues and other businesses who suffered from the government shutdown.
A concern that many of you have expressed, regarding the stock market, has been the amount of government spending. With $2T in COVID Relief to businesses and individuals last year, followed by $6T in passed and proposed spending this year (so far), many have asked if this will kill our economy and the stock market. The good news: it will most likely spur the economy and the stock market for the next few years. Those dollars, no matter how poorly allocated will, ultimately, land in business and individual pockets, only to be taxed again, thus reducing the velocity of money (don’t raise your political feathers – both parties have famously learned how to waste tax dollars). The bad news: The debt will be left to our children and grandchildren. Is there any wonder why cryptocurrencies like Bitcoin and Ethereum have become so popular?
Businesses are consistently reporting inflation in their input costs and CPI can be expected to be on the high side for several months. I expect that much of this is transitory. In March, the government sent out $1400 checks in March and April to about 161 million people. It is very likely that most of that money will be spent. Combine the flood of spendable cash with the fact that many can make more money sitting at home than they can working, and you have the classic inflation scenario: too much money chasing too few goods. With over 7.5 million job openings, we only had 266,000 takers last month. With so few working, the supply of everything from golf clubs to lumber is paltry in the face of all that cash/demand. Lumber has quadrupled in price since the beginning of 2021. The lumber mills were mostly shutdown last year and are having a very difficult time enticing people back to work. Many other items are not to be had at all. Since the additional $300 weekly payments, on top of unemployment payments, has been extended until September, we may experience this until then. The breakeven for going back to work is about $21/hour when considering favorable taxing of benefits. Another consideration, especially affecting women, is the schools staying closed and their children studying from home.
Hopefully, schools will reopen and fortunately, around twenty states have suspended the enhanced payments and they are beginning to see more people taking jobs. As this continues, we should see some of the inflationary pressure relieved.
The longer-term inflation pressures from the incredible amount of “stimulus” will not be felt until later. The Federal Reserve has already massaged their inflation mandate to accept a rate above 2% for some time. So, a measure of 3%, which to you and me is 4% or 5%, is okay for a year or two. How will this affect the markets? Many businesses thrive in a moderate inflation economy. Inventory turnover is not as pressured since it becomes more valuable. For others whose input costs may be half or less of production cost, it makes for larger gross margins and many expenses are fixed (machinery, office and factory rents and other laggards) while selling prices rise.
Then of course, real estate does especially well. With no leverage it keeps pace. If you pay 20% down on your home, it returns more than almost any other investment. Say you have a $500,000 rental home with a $400,000 mortgage. If inflation is 5%, your investment will be worth $525,000 at the end of one year. You have gained $25,000 on $100,000 invested, or 25%. That is the power of leverage in an inflationary market. This is the same strategy we employ when choosing REITs (Real Estate Investment Trusts). Not only do we believe we are getting good buys on the underlying real estate, with attractive dividends, which are taxed favorably due to the pass-thru depreciation, but we are also benefitting from inflation, in higher rents and property valuations.
Inflation is the enemy of cash and debt. Assume the same 5% inflation. And assume you could find a bond paying 6%. After tax, you net 3 or 4%. 10-years later you will know the meaning of “a safe way to go broke slowly”.
Another concern: How will we ever pay the government debt? How about with negative yielding debt? I wonder why the United States, the most powerful economic country in the world, is paying anything for its debt. Certainly, should be paying less. Many other countries have issued negative yielding treasury bonds (you pay the government an interest rate for holding your money). Currently, the global supply of bonds with negative yields is almost $19 Trillion (20% of the world’s investment grade debt).
Low and negative interest rates present substantial challenges for retirees and an existential threat to pension funds, insurance companies and endowments that all need a positive targeted rate of return to meet their financial obligations.
We believe the solution to low yields is a combination of the following: 1) preferred shares are paying in the 5% to 7% range, 2) property owning REITs are paying in the 4% to 7% range and mortgage REITs paying more. We expect the real estate will rise in value providing some portfolio growth (especially if there is some inflation) in their rents and hence, dividends will rise accordingly. By adding some Defined Parameter Investments, we can add some moderate growth with substantial downside protection, making for and excellent retirement portfolio.
By allocating the proper amount of investment monies to retirement needs, we can provide for necessary income and allow the balance to be invested with a higher growth orientation.
Defined Parameter Investments (DPI)
A typical DPI will have a cap (maximum you can earn in one year) and a buffer (the amount the underlying index can drop before you lose any of your investment). They range in caps and buffers, but are fixed for the entire year. Buffers are available in various percentages, with 9% to 15% being the most common. The caps adjust to the buffers with the typical spread around 25% (9% buffer with a 16% cap), but some months caps may be higher than the spread, due to market circumstances.
As an example, the DPI may be tied to the S&P 500 and say its start date is June 1st. Assuming a cap of 15% and a buffer of 10%, if at the end of one year the index was up 14%, the return would be 14%. If the index was up more than 15%, the return would be capped at 15%. If the index dropped by 10% or less, the return would be 0. If the index dropped by 13%, the loss to the investor would be 3%.
By investing in these at various, appropriate and opportunistic times, throughout the year, it is very likely that even in a twelve-month period with market losses, other start dates may experience some gain and others their maximums.
One more important characteristic of DPI’s is they are fully liquid throughout the trading day. Sometimes it is advantageous to buy them late in their 12-month life and sometimes it is advantageous to sell them early. Prices adjust throughout the day and there is no surrender charge if you decide to sell early.
Bitcoin & Ethereum
Cryptocurrencies come in many styles, with Bitcoin and Ethereum being the most prevalent.
We invest in both, much like we did gold for many years. Bitcoin is viewed by many, much like gold – as store of value, while Ethereum is used more easily as a currency. We only allocate a small percentage of one’s portfolio to these, but believe it is important to have some allocation to each. There has been extensive adoption of these, by many large corporations and we believe they will only become more valuable as our government continues to spend and print more dollars.
We hope everyone is able to resume their pre-COVID life and enjoy the rest of this year, seeing friends and family, along with the other activities you will enjoy. From all of us at Beck Capital,
Investment advisory services offered through Beck Capital Management, a registered investment adviser.
This material represents an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied.
Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Past performance does not guarantee future results.
A REIT is a security that sells like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages. REITs receive special tax considerations and typically offer investors high yields, as well as a highly liquid method of investing in real estate. There are risks associated with these types of investments and include but are not limited to the following: Typically no secondary market exists for the security listed above. Potential difficulty discerning between routine interest payments and principal repayment.
Redemption price of a REIT may be worth more or less than the original price paid. Value of the shares in the trust will fluctuate with the portfolio of underlying real estate. Involves risks such as refinancing in the real estate industry, interest rates, availability of mortgage funds, operating expenses, cost of insurance, lease terminations, potential economic and regulatory changes. This is neither an offer to sell nor a solicitation or an offer to buy the securities described herein. The offering is made only by the Prospectus.
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