Do office perks make sense? A look at tax rates on labor.

Direct taxes on labor shape a lot of relevant decisions on how best to reward employees. Large tax rates make non-cash benefits such as free lunches, free coffee and snacks in the break room, or paid vacation time more valuable in comparison to direct pay increases.

I’m going to dive into the the US tax system, specifically in my home state of California, to see what tax rates really are and how progressive they are. I’ll start with some charts, then explain my methodology and cite some sources.

The above chart shows marginal tax rates based on income level. The x-axis here is not scaled – the dollar amounts selected are those that affect the direct tax rate on income going forward. If it was a line graph, the lines would be horizontal with a discrete jump at each of the income levels shown. As you can see, the tax rates start at 19.8% and peak at 53.1%.

The line chart above shows the percentage of actual income taxed. Again it starts at 19.8% because that first dollar earned hits the basic payroll taxes (social security, medicare, unemployment insurance). It takes a while to ramp up because the federal and state income taxes are more progressive and start with zero rates (aka the standard deduction).

Methods:

The table above shows all of the different rates I calculated. The payroll tax rates tend to start at zero income and hit a dollar cap per employee. The standard deduction for a single taxpayer with no dependents is subtracted from both the state and federal returns. The reversion in marginal income tax rates hits when the FICA (Social security plus Medicare) tax rate drops to zero.

There are a number of notable simplifications I made here in order to make the chart simpler. Credits and deductions affecting special groups are ignored for example (EIC, child tax credits, education credits, dependents, etc). None of these affect payroll taxes, only federal and state. The bulk of these are itemized deductions for higher earners so they won’t effect decisions on rewarding young median workers anyway.

Thoughts:

My goal here is to get as close to a pure tax rate for labor as possible – meaning if an employer directly pays $50,000/year for your labor, how much of that do you get to keep. Payroll taxes are very much a part of this; whether they are hidden on the employers side of the ledger or visible on the employee’s side, they are still percentage based on what the employee actually makes.

For an employer, you can see that spending extra money to have little perks like free coffee or the occasional catered lunch can make a lot of sense. Not only do you get the business write off and bring people together, but you would also have to pay double that cost for that median worker to purchase that same item.

It was fun putting this together. I hope you find this interesting and thought provoking in your own way.

Sources:

Payroll taxes (the second one’s easier to read but both give the numbers):

https://www.edd.ca.gov/Payroll_Taxes/Rates_and_Withholding.htm

https://www.thebalancesmb.com/payroll-taxes-3193126

Federal tax brackets:

https://taxfoundation.org/2019-tax-brackets/

CA state tax brackets:

https://www.bankrate.com/finance/taxes/state-taxes-california.aspx

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Policy implications of Modern Monetary Theory

Modern Monetary Theory (MMT) is often thrown about like a political football, with the two sides painted as responsible cries to reduce the debt versus the big spending basic income and free college for all types who see free money within their grasp. In reality it is neither.

The national economy is often simplified on a dollar-and-cents basis as a debt and GDP. However, this simplification is inaccurate. The national economy is actually a collection of 327 million people, 240 million of working age, and their productions and interactions.

The key difference here is that these people will be in place and aging regardless of national policy. An austerity-driven effort to cut costs and repay debt functions by cutting jobs and excluding people from economic activity- which is cruel, wasteful, and misguided. When Greek austerity forced the young to leave the country and reduced their GDP by 25%, it actually made the debt problem worse.

The government needs to stop thinking of labor as a simple commodity that can be stored in the ground or pumped out like oil. Instead, labor is a resource that must be directed relentlessly toward the public good year after year – and if this labor is not used then it is wasted in a way much more damaging than spoiled fruit.

Key thoughts on MMT:

1. The money created by a central bank is not free, and where it is spent matters a great deal. Think of it as economic rebalancing when this policy is used. Though the money does come from elsewhere in the economy, most will agree that our economy is highly off balance.

2. We have a very low labor force participation rate of 62.8%. This hit an all time high a bit under 68% in the late 1990’s and never recovered from the drop in the Great Recession. Traditional economic theory tends to see this as structural unemployment which is a permanent fixture to be ignored. MMT says that structural unemployment is due to government policy and needs to be actively addressed.

3. There are obvious causes of structural unemployment that anyone can take to mind. Unfortunately this whole line of thinking is often brushed aside by moral judgments against people who are “unwilling to work.” Here are some causes of structural unemployment that can be addressed:

A. Employers heavily favor those with strong work histories. The longer a person is unemployed, the more this bias will stick. This creates a sub-class of unemployable people who are effectively locked out of the national economy.

B. Employers heavily disfavor criminal histories. Misdemeanors and Felonies make a worker seem more dangerous and risky, so a youthful mistake can easily lock a person into an unemployable sub-class.

C. The number of jobs available is limited and highly concentrated. This is because jobs flow around where money is being spent and private sector money is highly concentrated. Cities like San Francisco often struggle to fill $20/hr jobs because the earners have to live in their vehicles, while cities with ample housing have little money being spent and very few jobs.

4. A core principle of MMT is that government policy directly affects unemployment. Contractionary government policy (higher taxes, lower spending to pay off debt) aims to pull money from the private sector. Those who control this money aim to keep it while those depending on labor to earn their living are tossed aside. Result: high unemployment. The opposite extreme of highly expansionary government policy (Like the “Great Society” initiatives combined with Vietnam War spending), cause an excess of jobs and a cycle of wage inflation alternating with price inflation. Note that the resulting inflationary 70’s did not happen because of debt levels, but because of excess spending levels.

Final Thoughts:

I encourage everyone to think outside the box for a bit. Throw your labels and ideologies aside and think about the problems of the world today, specifically in the US. Does it make sense to care about the conditions of immigrants at the detention center only to throw their concerns aside once they enter the country? Does it make sense to morally condemn those who live in tent city poverty without providing them any path towards gainful employment?

As I jumped into in my previous article, right-to-work legislation bringing back a CCC type labor force makes a lot of sense. People could sign up, get room, board and a uniform, and go out towards infrastructure and environmental cleanup projects. The work would not be easy and the pay would not be high, but it could reverse some dangerous trends and foster national unity among those who feel discarded.

Also, and I hope others agree with me here, I see Social Security as an essential feature of the US system and not something for the budgetary chopping block. Means-test it, tax the payouts progressively, but make sure that we don’t re-create the miseries of leaving defenseless elderly to die in shameful poverty.

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Modern Monetary Theory explained

There is a lot of talk about MMT and it’s political ramifications, so I think it’s important to understand the basics. Like anything else, it is actually much simpler than it appears. Technical terms about how the government spends money before it covers the expense make what is essentially a revolving credit line with the federal reserve sound complex and throw you off the real questions.

Anyway, here’s my take on it.

1. A central bank is a branch of the government. This has certain ramifications including that governments will always be able to pay off debts held in their own currency.

2. Central banks have a monopoly on the supply of currency in the system. They can and do create money at will. Quantitative easing is a fancy term for increasing the supply of currency as seen by the size of the Federal Reserve’s balance sheet. Now the Fed is reducing the size of its balance sheet, sometimes referred to as quantitative tightening.

3. Governments create the ultimate demand for a currency in the form of tax liability. A newly minted currency has no direct value. The government needs to pay for services in that currency, so they create a demand for it by requiring tax payments.

4. Inflation can be managed by adjusting the supply and demand of the currency. This takes some explanation.

When the government spends money, it is initially sent from the central bank. This increases the size of the Fed’s balance sheet which increases the money supply. This increase is then offset by collecting taxes to pay back to the Federal Reserve and by selling debt securities to the private sector, which both reduce the size of the Fed’s balance sheet. That’s how normal operations work.

Increasing the supply of currency can be done by having the government spend more money. MMT lumps the central bank under the government label for simplicity in this regard. When the central bank purchases treasuries, bonds, stocks, etc., the overall monetary effect is the same as the US government raising federal salaries or building infrastructure.

Increasing the demand for currency is most simply done by raising taxes and fees. Simply put, raising taxes is deflationary and cutting taxes is inflationary.

Relative values of currencies are a bit more complex, but the forces here are powerful and worth mentioning. Raising interest rates tends to increase the value of a currency in two ways. First, it increases foreign investment demand for a currency (Banks have to hold government debt as top tier collateral, and earning 2.25% on a US Treasury can be preferable to a negatively yielding German bund). It also encourages reductions in private sector debt which reduces the money created by the fractional reserve banking system. The trade balance also effects foreign demand for currency, as purchases from a foreign country require an exchange for that country’s currency. This is a big part of the reason Japan was able to increase its money supply for decades without causing inflation.

5. Unemployment according to MMT is a bit more unique. According to the theory, taxes create unemployment by causing a demand for currency which must be met by working. Spending reduces unemployment by creating jobs allowing the currency to be earned. Simply put, the government controls the supply and demand for money, so it can always push towards “full employment” (meaning everyone looking for a job gets one) by spending more and it can always manage inflation by pulling money from the private sector both by raising taxes and selling debt securities.

The last point there has the politically charged words “tax and spend.” I urge you to keep focus on the theory and not let those words derail your train of thought. Consider how Keynesian economics is used to justify crazy government spending in recessions even though the theory itself calls for government austerity in good times which never happens. What the money is spent on, how it is spent, and where it comes from make an enormous difference and they are mainly political questions.

6. Right-to-work laws.

Now I will delve into politics by mentioning the biggest political suggestion by MMT economists. Right to work laws are not new. The French had them (for a few years at least) after the revolution in 1848. Franklin Roosevelt used agencies such as the CCC and TVA to directly increase employment. China today uses government-owned corporations to employ large numbers of people even if they operate at a financial loss. The point here – this idea isn’t new or unprecedented.

One of the main flaws that MMT proponents see in the current US system is that big recessions cause employment which pushes many people from the lower working class into tent city squalor. These tent city residents soon become unemployable as no one in the private sector will trust them to become good, reliable employees. The government could allow these people to come into an office, sign up for a job, then get room, board and a small paycheck for work they have available then these people would be able to return to private sector employment in the future. The work could involve infrastructure, environmental cleanup, or a number of other areas … think of what the CCC and TVA did.

Final note.

The whole MMT explanation of how the government spends and procures money (in that order) is mainly a debunking of the common reasons to push austerity. The government will not run out of money and go bankrupt. Hyperinflation is not just around the corner. On the other hand, common austerity measures of higher taxes combined with lower government spending does cause unemployment to rise, which can have devestating effects on both the economy and the political climate.

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John’s Utopia

I’m actually somewhat excited about the upcoming election in the sense that we’re in a period of political change. The old parties seem just that – old. More outsiders are going to be heard and we’ll see what gains traction. We’ve long been on a two-tier economy where the upper end of the upper middle class is doing great, but everyone below that still feels knocked down a peg.

That being said, I’m going to quickly summarize my suggestions for change. I have no say in anything and no one I know of talks about what I’m suggesting, but just for fun I’ll spell out my views anyway.

The way I see the problem…

True growth and innovation comes from small business. While corporations can focus gobs of money on technology upgrades, they are still utilizing only a small number of engineers to tackle a problem in a big corporate way. Meanwhile, more students then ever are learning math, science, engineering, etc. and they can start from scratch to create something unique, like a whole different corporate organization and culture. Think of the young Steve Jobs, Mark Zuckerberg, Michael Dell, and so on.

The modern world is geared to heavily benefit the asset rich at the expense of everyone else. Entrenched companies can buy out competition with abandon – then ultimately dismantle them because they don’t mesh with large scale corporate culture. Captured regulators make it outrageously expensive to start out in an industry. Young entrepreneurs are stopped at the gate, unable to even compete.

Worse yet, large corporations pigeonhole their employees preventing them from developing and utilizing their talents and keeping their wages low. A small business employee needs to learn a lot about how the business runs, and can gain a knowledge set to start a new business of his own. Large corporations get employees to specialize and focus on a small piece of the puzzle so that they have nowhere to turn if they want to change and develop – particularly as competitors become more scarce and non-compete clauses are rampant.

My particular solution…

Regulation needs to be progressive, just like income tax rates. The more money a company makes, the more stringent. For example, getting a home kitchen checked out for a small home bakery should be fine … until your sales hit a point where you really need that commercial-grade license.

Corporations should be forced to compensate employees better as revenue climbs. Two ways I see this … one is to limit total CEO and upper management pay packages to a set multiple of median employee incomes – thus encouraging a pay raise in the middle. The second idea would be to require companies over a certain size to use a unionized labor force. Either way, the idea is to empower people to reach their potentials, either by allowing them leverage against large employers or to make it easier for them to compete if they set out on their own.

Special taxes need to be applied to any business with more than a 10% market share in an industry. This should be highly progressive and quite high when an industry is more than 80% dominated by a single company. If it’s really a natural monopoly it’ll survive – if not then the owners will split it apart themselves.

As you can imagine I have a lot more ideas on how to change things, on financial regulation, combatting fraud, litigation reform, and a host of other issues. That could go on forever though, so I’ll stop here … my main point is that our biggest economic and sociological problems would start to fade if we could just tilt the rules back in favor of small business.

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Are credit measures the best metrics for predicting stock market moves?

There were a number of financial articles I found intriguing this week, particularly centered around the following:

“The net effect of these investor groups is that they together shed $1.1 trillion of shares (included in these categories, and spread over them, are ETFs). But the $1.1 trillion of shares that these investor groups shed over those five years was overpowered by $2.95 trillion of share buybacks over those five years.

https://wolfstreet.com/2019/04/08/what-would-stocks-do-in-a-world-without-buybacks-goldman-asks/

You can read the whole article if you’d like the charts and such, but it’s an interesting phenomenon to think about. Investors actually pulled 1.1 trillion out of stocks while corporate buybacks flooded 2.95 trillion in, resulting in a massive bull market as buying outpaced selling by 1.9 trillion.

Most investor classes have been bearish because they are trained on classic valuation models, and no matter how you slice it the idea of a “new normal” of slower growth does not justify P/E ratios that are way above average.

So will the stock market plummet? It’s tempting to think so. However, a very interesting podcast on RealVision by Brain Reynolds explained an interesting phenomenon.

After the problems with Detroit pension funds, remaining labor groups have been increasingly pressuring politicians to fill pension shortfalls. State and local taxes have been rising and putting larger amounts of money into these funds. The funds are typically expected to make returns around 7%, and they attempt this by throwing ever more money into leveraged forms of corporate debt.

This corporate debt goes more and more into stock buybacks. 2018 had a record $800 billion in corporate buybacks, and I’ve seen predictions of $1.2 trillion for 2019. If that holds true, stocks have no option but to tear higher.

Brian Reynolds explained that when credit markets start to freeze up, the cycle can quickly turn to panic like in late 2018, yet the market will be tearing higher like a switch has been turned on once the credit thaws again.

In such a market, credit is by far the most important indicator. Credit creation spills over into all asset classes, flooding the stock market with liquidity so it will blindly tear higher only to let it drop in a panic when credit creation drops to a smaller level.

So what credit metrics are there? Well, the primary ones tend to be the yield curve, such as 10 year bonds vs 1 year, and bond spreads, such as corporate debt vs government debt. These can be problematic indicators however when central banks around the world try to directly manipulate these measures.

I tend to think that the volume of credit creation is the key here, and a manipulated rate is not a reliable indicator. That begs the question, what do we use? I’m not sure if ordinary investors like me can access more direct information. Some things that might help however include:

1. Overall debt levels, perhaps found from various articles… make sure you sell if they stop rising.

2. Central bank policy – the Fed can talk more dovish, but I’m nervous about stock price declines until they lower rates and switch back from reducing the balance sheet to enlarging it.

3. Technical Analysis on the S&P 500. This may actually be your best bet because the way the money flows which drive the price work differently in a low-liquidity selloff than a high-liquidity rise. Thus the way the price itself moves may be the best tell, as these patterns will help determine direction. If the credit creation switch is turned on, that will show and likely last between a few months to a couple years before being switched off again.

Caution: this is not the same as saying buy the dips … buying the dips in this market will actually be dangerous. It is saying buy when you have confirmation of the loose credit trend continuing and sell when you see signals of credit tightening.

I’m no expert in technical analysis and I can’t tell you what price signal will work – I can only suggest you find what metrics fit the trend in the last 5 years and ride them through until we eventually hit another regime change in what drives the market. This regime change could involve the slowdown in the rest of the world affecting the US, but I think it will more likely be driven by politics, when politicians are driven to find other economic levers to mess with.

Buena suerte, and as always I hope this gives you something to think about.

—– Some afterthoughts —-

It occurred to me that there was a recent regime change we need to think about… expansionary fed policy was the main driver, leading to credit spillover into stock buybacks, until 2018. After that the Fed tightened policy, and the rest of the world started responding to the tighter credit and going dow.n

Then the tax change was the next policy lever pulled which highly incentivized corporations to “repatriate” dollars – many of which were used for stock buybacks. That’s why we see record stock buybacks going forward for now. That begs the question of how long can it last?

Of course the money going in to fill the pension funding gap is pouring in as well – but if this money comes from local taxes while credit is tightening and world growth is slow, we’re bound to hit a recession which would spook the markets.

This leads me back to my original thought which was wait for the fed to actually reduce rates toward 1% before hitting a high conviction bullish outlook. Until then think cautious … when the steady climb starts to turn be ready to cut and run until you see a solid base forming. Be prepared for prices to drop as fast as they did Jan-March 2018 and again Sept-Dec 2018.

I don’t think this tax change repatriation spillover will be as steadily reliable as QE spillover in driving stock markets higher … it could be more high intensity but short-lived as companies rush to take advantage of the tax law before it can be changed. Also keep in mind that the money allocated to stocks will be dispersed over more high profile IPO’s this year. This will be a drag on the overall market because it will absorb money allocated for stocks (most of which is invested blindly and bluntly ETF-style). Essentially, if Uber is valued at $10 billion, then the IPO will pull $10 billion which would have been allocated to other stocks – acting the same as if $10 billion was pulled from stock ETF’s.

Anyway, I didn’t want to rewrite yesterday’s post but I though this was important enough to mention.

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Why does an inverted yield curve indicate recession?

There’s a lot of discussion about the importance of this classic indicator for recessions, so let’s take a look at what it typically means.

A yield curve inversion represents a tightening of credit in the economy due to a collapse in loan demand.

Banks borrow short and lend long, making their business model hard to operate. Insurance companies, pension funds, etc are also steady buyers of debt.

This buying power overcomes the demand for loans as businesses don’t find the need to expand. Buying overpowers selling, pushing down the yields of mid ranged debt.

Less borrowing and spending means less money cycling through the economy – ultimately reducing overall earnings. Cost cuts are the natural response of companies to reduced earnings, which feeds the cycle more.

Note that it is actually the collapse in credit demand which leads to a recession – the inverted rate is merely an indicator of this. If central banks supported the yield curve it would merely mask the signal, it wouldn’t actually increase credit demand. Also note that the slowdown following this drop in credit demand doesn’t have to become a technical recession, though it does mean things are slowing.

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What drives the markets?

We’re about a decade into an amazing bull run the stock market, with valuations climbing ever higher. I often hear questions on different nuances, almost always of course dealing with the way to earn the quickest or best returns.

In order to understand what drives returns, the most important thing is understanding flow of capital. You need to understand why money is piling into an asset and why you should expect this to continue. This may sound simple or obvious, but most people don’t think of things that way at all – they look too much into the underlying asset or the headline news. Most financial articles you read are nothing but noise – they take the most recent stock move and tie it to a recent headline. This is easy journalism which provides an endless amount of analysis to sell, can sound somewhat convincing at a surface level because it reflects something you’ve already heard and many are talking about, but really tells you nothing about what’s going on beneath the surface.

In order to understand flow of capital, I’ll start by introducing a number of investment strategies. Investing is as much art as science, and there are many ways to play it. Regardless of your strategy however, it takes patience, discipline, and conviction in your approach. I’ll list a few approaches and then brush into my view of things.

Passive investing / ETF’s:

Most funds today are passive rather than active, so I’ll start there. A passive fund, like an ETF, will blindly throw money at a benchmark allocating based on price. If a stock doubles in price, it’s weight in the index effectively doubles, and more money is allocated there as a result. Valuation is thrown out the window, as markets are assumed to be efficient in pricing. Downside protection is thrown out the window, as diversification is assumed to be adequate because you hold all the shares in the index. This strategy is a great way to minimize management fees, as very little oversight or research is required. However, I tend to believe that this strategy going mainstream will simply drive valuation to wilder cycles than ever before. When money piles in over time all seems well, but when this influx halts or reverses it could easily overshoot valuation to the downside. Most investors in this area tend to be momentum driven by nature, and will reallocate away when their gains don’t meet expectations, creating a self-feeding cycle lower.

Value investing:

For active managers, some focus in valuation. This tends to offer more downside protection, as reduced price can generate more interest rather than the reverse. However, there are many so-called “value traps” out there that seem to offer good valuation for years but simply don’t show the gains of momentum stocks leaving you with sub-par investment returns. Please understand though that value investing is by no means a dead end, it just isn’t a panacea – a good value investor should be able to explain not only why valuation metrics are good, but what catalyst is expected to drive valuations higher and approximately when this is expected to play out. Without the why and the when – or the signs to watch for – how can you keep the discipline to hold the investment until it gains? How do you know if it will ever gain?

Technical analysis and investing:

People often see the simplistic side of this approach- “the such and such stock price shows a classic formation which indicates movement to the upside with resistance expected at this price level”. It’s not quite that simple… traders who are successful with this style of investing often focus on a specific market and find what works there. They might look at oil for example and follow a number of indices they find relevant which often include currency fluctuations and trends energy users (like airlines and commercial freight). They also pick a time range that tends to be short term … some are measured in hours, some in days, weeks or months but typically not much longer than that. The big advantage to this approach is that you always have something to work on, and you have relatively steady ways of quantifying your success and value, so many active fund employees invest this way.

Macro investing:

The idea here is that you try to find the overall trends in the market and invest accordingly. Is the dollar strengthening, putting pressure on gold an emerging markets? Will bond yields continue to rise or fall and who will gain as this happens? Note that political events can affect this, but it is primarily related to identifying cycles … what type of market are we in, what are the primary drivers, what are the signs that the cycle is shifting, and so on. This is what I’m personally most drawn to, but it has a major drawback … there isn’t always something great to invest in. I like using the ocean as an analogy here… technical and momentum investors try to follow the waves, making something on each one. Value investors pick a few surfers in hopes of finding a good one for the team and trusting him to make it. Macro investors focus on the tides. This can be powerful, but you might have to wait a while before the tides are really moving.

Back to the original question – what drives the markets?

Over the last decade, we have had unprecedented easing of central banks worldwide. The federal reserve is perhaps the most important player, but the amount of easing by the European Central Bank, Bank of Japan, and Central bank of China has been much heavier. The result has been a flood of new money to “invest”, almost like a dam opening up to make the river flow bigger. In addition, capital conditions for global investment have eased like never before.

This has lead to what I like to think of as the “everything bubble”. Housing has effectively become a global investment asset instead of a place for workers to live. Whatever it is that big funds pour money into – stocks, bonds, real estate, etc – have soared while wage inflation stayed low. This has a number of implications including the worldwide political instability we see, but I’m going to focus on markets.

In a sense, the markets now are really simple, but more patience is required than ever which can be excruciating. Essentially, the flood of central bank money has been driving markets ever higher in a way that far outpaces other drivers. Right now it has simply become a story of one ratio: the quantity of money allocated to investments compared to the quantity of available assets to invest in.

Take a quick look at recent events in this area. The Federal Reserve began to tighten in two ways – reducing its balance sheet holdings while increasing interest rates. The US dollar began to strengthen. This put a lot of pressure on emerging markets, so they all had to tighten central bank policy in response. Emerging market assets slumped in value. The BOJ, ECB, and bank of China slowed or stopped their easing measures so that their currencies wouldn’t drop too much. The US dollar is still the worlds biggest reserve currency and the biggest currency for international trade, so these entities cannot just let their currencies slip.

Then the tax cuts went through allowing big international corporations to “re-patriate” their overseas cash holdings without the big tax penalties of the past. This money flooded into stock buybacks and US treasuries. The US market didn’t see a taste of the liquidity drying from the world until mid 2018, but the move was relatively mild (though somewhat larger in the most crazily valued tech names). Markets don’t move in a straight line however, and the low in December was followed by a new wave of money. The Federal Reserve even spoke dovishly in January to help keep valuations high. Worldwide markets aren’t seeing the same gains however, and even gold has been under pressure as money has flowed into US dollar denominated assets.

However, the Federal Reserve is still reducing its balance sheet and other central banks are still waiting before they ease further. Also, the US budget deficit is higher than ever. This that means that the money flow from central banks isn’t raising the level of money allocated to investments, while the amount of investable assets – in the form of US treasuries – is still increasing. That is an outward tide which warns of lower valuations ahead. Be patient my friends and hold more money aside for a time when valuations are better.

How do you know when to stop waiting? Simple. The Federal Reserve will start loosening the floodgates again. Once asset values go down enough to spook the banks and politicians, the Federal Reserve will lower interest rates and then start to increase their asset purchases again.

Don’t try to be clever and front-run this process. The magic is in going with the tides, not anticipating a future move before other investors. Let the Federal Reserve reduce rates to 1% before you become really bullish, otherwise you’re fighting upstream, it’s really that simple – and the patience required will be excruciating.

In the last down cycle back in 2008, I made a big mistake that I don’t want to repeat. Valuations were getting better and I was all in before that crash in fall 2008. I witnessed a massive margin call as the CEO of Chesapeake lost his shares and pushed the stock below $12 a share. I knew this was a crazy good buy but I couldn’t do anything! If I sold my existing holdings it would take a few days before Ameritrade would let me re-invest the money, and even if I had money to transfer in there was a waiting process. A few days later the stock was back over $25. The bottom of the market hit in March 2009 and I couldn’t keep investing because I knew my days of working in my HVAC construction job were numbered. This time I want some money to allocate for crazy bargains if they happen. Also … the central bank turned the market last time just as it will this time. When that happens, if last time is a guide, the US market will pick up first while emerging markets lag for a year or two. Then emerging markets will skyrocket as risk-on once again dominates.

Good luck everyone, and remember- the key to correctly applied patience in investing is to know why you expect a move higher and you give yourself signs to watch for. Without that you’ll be subject to the folly of losing patience prematurely (like I did with emerging markets back in 2010), or blindly being patient in a “value trap” that never seems to go anywhere.

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