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October 10, 2017

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The Good, The Bad, and The Money Volume 2

October 17, 2018

Fun fact one: Many people think that their local gas stations increase gas prices based on the competition. However, that’s not entirely true.

 

You may have heard of The Organization of the Petroleum Exporting Countries (OPEC), an intergovernmental organization of 15 nations which was founded in 1960 in Baghdad. OPEC’s mission is to "coordinate and unify the petroleum policies of its member countries and ensure the stabilization of oil markets, in order to secure an efficient, economic and regular supply of petroleum to consumers, a steady income to producers, and a fair return on capital for those investing in the petroleum industry.” Essentially, OPEC helps to stabilize the cost of oil, which in turn affects fuel prices in various countries, states, and local areas.

 

West Texas Intermediate (WTI) is classified as a medium grade of crude oil because of its relatively low density and sulfur content. The commodity markets track WTI when pricing oil at the state and local level.

 

In the beginning of September, WTI was trading right around $68 per barrel. The U.S. Energy Information Administration recently stated gasoline prices tend to increase when the available supply decreases relative to real or expected demand or consumption. Gasoline prices can change rapidly if there is a disruption in crude oil supplies, refinery operations, or gasoline pipeline deliveries. Even when crude oil prices are stable, gasoline prices fluctuate due to seasonal changes in demand and in gasoline specifications. There are times throughout the year when gasoline is required to be more or less evaporative. For example, environmental regulations require that gasoline sold in the summer be less prone to evaporation during warm weather. This is part of the reason gas is higher in the summer. So, take a ride throughout your local neighborhood and you’ll see how gas prices vary. But don’t forget that there are other factors that play into the cost of your local fuel, such as taxes, seasonal and weather effects, location, and supply and demand.

 

Let’s take a look at the some things that have happened in the market and economy throughout the month of September.

 

The Good

 

A few positive things to point out throughout the month of September were consumer sentiment data, wages, inflation, and market performance.

 

Consumer sentiment is important because it tells us how investors are feeling about the market. Throughout the year, investors’ concerns over and expectations for market performance change. As we know, the market has seen substantial growth over the past several years; however, investors are certainly expecting a market correction is due.

 

Since 1987, the American Association of Individual Investors (AAII) has completed a weekly survey that asks a simple question: ‘how do you feel about the market?’ Investors typically respond in one of three ways: either they are bullish, bearish, or neutral.

 

According to AAII, bullish sentiment that stock prices will rise over the next 6 months dropped 10.1 percentage points to 32.1%. This drop ends a consecutive streak of optimism above the historical average of 38.5%. From a bearish perspective, investors expect stock prices to fall over the next 6 months to 32.8% which is 6 percent more than the previous week’s report. Of those surveyed, about 35% expect the neutral sentiment of stocks will stay essentially unchanged over the next 6 months.

 

As stated in the previous month’s article, I will be discussing consumer sentiment. The Consumer Sentiment Index (CSI) is a consumer confidence index published monthly by the University of Michigan. This index is normalized to a value of 100 in December 1966. Each month, at least 500 telephone interviews are conducted using a sample of the continental United States.

 

The most recent survey completed by the University of Michigan shows that U.S. consumer sentiment jumped to 100.8 in September of 2018. This represented a significant increase from the previous month, when consumer sentiment was right around 96.2. The University of Michigan’s report beat market expectations of 96.7. It is the second highest level since 2004, only behind the March 2018 reading of 101.4. These expectations were the strongest results since July 2004, largely due to more favorable prospects for jobs and wages.

 

 The Bad

 

As of the second quarter of 2018, U.S. national debt surpassed $21 trillion dollars. But who really holds the debt for the United States? Some people believe that the debt is held primarily by other countries, although that’s not necessarily the case. In fact, two-thirds of the debt is held by the public. These are buyers of U.S. Treasury bills, notes, and bonds. Keep in mind the holders of those securities are individuals, companies, and foreign governments. The remaining third is held by what is known as intragovernmental debt.

 

Intragovernmental holdings are primarily composed of the Medicare trust fund, the Social Security trust fund, and Federal Financing Bank securities. Out of all the intragovernmental debt, the biggest debt holders are typically the social security fund and other trust funds.

 

Fun Fact Two: The social security trust fund – also known as the old age, survivors, and disability insurance program (OASDI) – and other trust funds within the government have been running a surplus for several years. According to the Social Security Board of Trustees, an annual surplus of $44 billion in 2017 increased asset reserves of the combined OASDI trust funds, bringing the total reserves to $2.89 trillion by year end. This amount is equal to 288% of the estimated annual expenditures for 2018.

 

Fun Fact Three: According to the Social Security Board of Trustees, an estimated 174 million workers had earnings covered by Social Security in 2017. Employees pay a 6.2% contribution from earnings up to a maximum of $128,400 in 2018, which their employers match. Self-employed workers pay double the contribution, or 12.4%. More than 40% of current beneficiaries pay income taxes on part of their benefits, and those taxes go to OASDI trust funds and Medicare's Hospital Insurance trust fund. The trust funds also earn interest ($85 billion in 2017 for OASDI trust funds) on their accumulated reserves.

 

 

It seems the OASDI has been running a surplus in funding for several years. In fact, the funds currently can pay full benefits to its beneficiaries until 2034, if nothing else is put in place. Take a quick look at this excerpt from the Office of Retirement and Disability Policy, a division of Social Security:

 

“The concepts of solvency, sustainability, and budget impact are common in discussions of Social Security, but are not well understood. Currently, the Social Security Board of Trustees projects program cost to rise by 2035 so that taxes will be enough to pay for only 75 percent of scheduled benefits. This increase in cost results from population aging, not because we are living longer, but because birth rates dropped from three to two children per woman. Importantly, this shortfall is basically stable after 2035; adjustments to taxes or benefits that offset the effects of the lower birth rate may restore solvency for the Social Security program on a sustainable basis for the foreseeable future. Finally, as Treasury debt securities (trust fund assets) are redeemed in the future, they will just be replaced with public debt. If trust fund assets are exhausted without reform, benefits will necessarily be lowered with no effect on budget deficits.”

 

Aside from debt, other concerns include wages and inflation. According to the U.S. Labor Department, cost of living is up 2.9% from July 2017 to July 2018. This cost of living rate outpaced the increase in wages of 2.7% over the same period. The concern is that if cost of living outpaces wage growth, total U.S. growth may be in jeopardy. According to The American Automobile Association (AAA), inflation hit a 6-year high over the summer due mostly to increased energy costs. As we welcome the 4th quarter of the year we should have our eyes fixed on consumer spending, wage growth (if any), and market performance over what is projected to be one of the best 4th quarters yet.

 

The Money

 

Mutual Funds vs ETFs

 

In response to a reader of my August 2018 edition of The Good, The Bad, and The Money, I was asked to explain some of the differences between exchange-traded funds (ETFs) and mutual funds. I wrote about ETFs and mutual funds about a year ago and thought it would be beneficial to cover in this edition. With that said, let’s take another look at their differences.

 

For years, investors have been looking at new ways to diversify their investment portfolios. But how exactly does an investor achieve this goal of diversification? In the past, investors would hold individual stock certificates for various companies they invested in. However, that strategy has changed, as investors are now utilizing the internet to research, buy, and sell various investments of their choosing. Investors are still looking for opportunities to diversify their portfolios while limiting the amount of risk they assume. Holding actual stock certificates and bonds could prove more risky than alternative investments that are available to investors today. This is where mutual funds and ETFs come into play. Let’s take a look at the advantages and disadvantages of each.

 

Mutual Funds

 

Created in 1924 by Massachusetts Investors Trust, a mutual fund is an investment vehicle made up of capital collected from several investors for the purposes of investing in stocks, bonds, money market instruments, and other securities. Money managers typically invest the fund's capital to generate capital gains and income for the fund's investors. Mutual funds provide a strategic way for investors to diversify their investment assets.

 

Here are a few advantages and disadvantages of owning mutual funds:

 

Advantages

  • Professionally managed: Mutual funds are professionally managed by individuals licensed and typically certified to pick stocks and bonds. They are often employed by large money managers like Blackrock or Fidelity. In this capacity, they are responsible for picking securities tailored to fit the objectives of the underlying mutual fund.

  • Diversification: Mutual fund managers have the availability to invest in securities across multiple market sectors. This is increasingly important, as it allows for an investor’s capital to be spread across the market, thus limiting the risk ratio in the portfolio.

  • Liquidity: Liquidity gives the investor the opportunity to make money on their investments while having the opportunity to withdraw funds as needed. This is important to some investors, as liquidity and capital availability are among one the most important benefits for investors.

Disadvantages

  • No intraday trading: This means that you cannot trade mutual funds as you do stocks. Mutual funds are traded at the end of the trading day at a price called Net Asset Value (NAV). It’s important to understand this, as trading in the mutual fund space can be tedious since you must wait until the end of the day to determine the price of the fund.

  • Not necessarily tax efficient: Typically, capital gains are processed at year end and distributed to fund shareholders. Investors have little impact or say on how capital gains are distributed, thus making it more complicated to determine tax efficiency.

  • Costs: Mutual funds always carry some costs, and these costs will decrease your overall rate of return. That is why it is important to understand how costs are baked into mutual funds. Some carry front-end or back-end costs, so an investor must understand how these types of costs work before investing in a fund.

ETFs

 

Introduced to the investment world in 1993, ETFs have become a go-to investment for investors. ETFs are marketable securities that simply track an index, bond, commodity, or investment such as an index fund. The price of ETFs changes throughout the day, as they are traded like common stock. This means that ETFs typically have higher daily liquidity and lower fees than mutual funds. ETFs are attractive investments because their performance can be tracked lateral to a stock.

 

Let’s look at a few advantages and disadvantages of ETFs:

 

Advantages

  • Diversification: Like a mutual fund, one ETF can be invested in a group of equities, bonds, or an index. In comparison to stock trading, an ETF can trade multiple stocks at a time, making it more effective than simply purchasing one stock at a time.

  • Cost: ETFs have lower costs because unlike mutual funds, they are passively managed and there are management fees baked into its expense ratio.

  • Trade like stocks: ETFs can be purchased just like stocks, which means they can be bought on margin and even sold short. ETFs also trade at prices that are updated throughout the trading day. This is important because investors can minimize risk by continually monitoring daily performance.

Disadvantages

  • Intraday pricing: Although the intraday pricing of an ETF is updated throughout the trading day, this might not be good for long-term investors (also called value investors). ETFs have two prices, a bid and ask. Investors should be aware of the spread between the price they will pay for shares (ask) and the price a share could be sold for (bid). In addition, it helps to know the intraday value of the fund when you are ready to execute a trade.

  • Costs: Some ETFs may not track a widely accepted index, which may result in higher costs and higher risk.

As you can see, there are several benefits of owning both mutual funds and ETFs. However, investors need to understand their risk tolerance, time horizon, and liquidity needs before investing in either investment. All in all, mutual funds and ETFs are great investments for the right investor, and they both serve a purpose in an investor’s portfolio.

 

Conclusion

 

As addressed previously, consumer sentiment data, wages, inflation, and market performance are all moving in a positive direction. U.S. debt has reached an all-time high and there’s still uncertainty as to how the economy will move going forward. As this series progresses, I’ll continue to address consumer sentiment, market performance, wages and inflation, and many other timely topics.

 

 

 

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