Zynergy

Retirement Planning

What the Russian Invasion Means for Investors

stock market

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Russia’s decision to invade Ukraine has caused a lot of uncertainty for investors. First and foremost, the main concern is the safety of the Ukrainian people and their sovereignty. However, there are side effects from the invasion that are being felt outside of Russia and Ukraine that have investors concerned. So, what does the Russian invasion mean for investors? What are some things investors can do to help alleviate the impact of the side effects on their personal financial situation? Below you will find three of the main investor concerns and how they can help counteract the impact.

Inflation – While inflationary pressure has been building over the past several months (due to a higher demand for goods and supply chain disruptions caused by the COVID-19 pandemic) we now have a new dynamic to deal with – Russia’s invasion of Ukraine. Many investors know that Russia’s main export is oil, but not everyone knows that it does not end there. Russia also supplies the world with other natural resources, including wheat, lumber, and metals (aluminum, palladium, nickel, and titanium). These natural resources are needed to drive our cars, heat our homes, and build new homes. In addition, metals are used in everything from automobiles to cell phones, to electric car batteries, to aerospace products. Russia has not yet decided to cut off the West from oil delivery or other natural resources. I find it hard to believe that Russia would move in this direction (as the Russian economy would have a very difficult time insulating that shock), but we cannot put anything past Vladimir Putin. Given the uncertainty of the invasion and Putin’s response to the West’s economic sanctions, the prices of these natural resources have increased over the past few weeks. While the US and its allies have committed to releasing 60 million barrels of oil from the Strategic Oil Reserve, this may not alleviate all of the pricing pressure. Therefore, it is safe to assume that prices will remain at an elevated level for the foreseeable future.

So, how can you best prepare yourself for higher inflation? First, you need to understand where your money is going. That is why we recommend that you track your expenses to determine what areas of your spending are more vulnerable to an increase in prices (e.g. heat, gasoline, electric, groceries). Once you understand your spending habits, review your budget. If higher prices at the pump or at the grocery store are causing strain on your budget, then you may need to adjust your spending in other areas. Typically, the first line item to look at is your discretionary expenses (or non-essential expenses). This can include dining out, entertainment trips to Starbucks, travel, etc. If you are feeling the pinch from higher prices then perhaps you can skip a night out, make fewer trips to Starbucks, or perhaps put the new TV purchase on hold for a few months.

Higher Interest Rates – The US Federal Reserve has two primary objectives: to maintain high employment and maintain stable prices. In response to the strong economic recovery coming out of the COVID-19 pandemic and growing inflationary pressure, the US Federal Reserve has decided to pull back on economic stimulus. To that end, the US Federal Reserve will most likely increase short-term interest rates. In fact, Federal Reserve Chairman Jerome Powell indicated that he supports an increase of .25% in interest rates in March. While some investors may welcome higher interest rates and a higher rate of return on their savings, it is not all good news. Higher interest rates can lead to a slowdown in economic growth and thus lower stock returns. In addition, higher interest rates can have a negative impact on the housing market and those who carry variable interest rate debt.

How best can you prepare for higher interest rates? If you are someone who carries credit card debt or if you have a variable interest rate loan, now is a great time to take action. As interest rates increase, the rate on variable interest rate debt will increase as well, leading to higher monthly payments. Paying off your credit card debt will not only help reduce the amount of interest you pay, but it will also free up money that you can put towards building an emergency fund or saving for retirement. If you have another type of variable rate debt, now would be a good time to look into refinancing the loan into a fixed-rate loan. Interest rates today are still historically low, so you may be able to find a good deal on a fixed-rate loan.

Stock Market Volatility – One thing I can say with certainty is that the stock market does not like uncertainty. Unfortunately, today there is no shortage of uncertainty. We do not know what the outcome of the Russia-Ukraine conflict will be; we do not know if Russia will try to move into NATO countries, we do not know if inflationary pressures will ease over the next few months, and we do not know how high-interest rates will go. Therefore, investors need to brace themselves for a period of higher stock market fluctuation. During times of uncertainty, the stock market is more sensitive to breaking news headlines. Any particular headline can cause the market to swing dramatically in any direction.

It is times like these that remind us of the importance of a well-diversified portfolio. In addition, you want to make sure that you are rebalancing your portfolio at least once a year to ensure your allocation is aligned with your risk tolerance. Turn off the financial news and remain disciplined. The stock market could be down 2.5% one day and up 3.0% the next day. Watching the financial news could cause an investor to panic, which can lead them into making a bad financial decision. Remember, investing is a long-term strategy. The markets are going to experience periods of above-average returns and periods of below-average returns. The economy is going to experience periods of economic expansion and periods of recession. But we know that the market heads higher over time. As an investor, you never want to take a short-term view of a long-term investment.

 

 

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Q: Why do a lot of experts and CNBC commentators say the stock market is overvalued?  How is the stock market valued?

A: Valuation is discussed a lot in today’s market environment.  Whether it be the value of your home, a share of Apple stock, an ounce of gold, or a Bitcoin, many are wondering how you put an appropriate value on investment or use assets in an environment where prices are soaring in many asset classes.

There are only three ways to value an asset:

  1. Discounted future cash flows
  2. Use Value
  3. Speculating that something I purchase today, someone will be willing to pay more for tomorrow

Discounted Future Cash Flows

I understand this sounds technical and complex, but it simply means what am I willing to pay today for future income.

In a simple analogy, let’s assume that you could purchase a money machine.  This money machine produces one dollar every day until the end of time.  Each year, this money machine provides you with $365 with no effort or maintenance costs.  How much would you be willing to pay for that money machine today?  $1, $10, $3,000?  I think we can agree that $1 would be significantly undervaluing such a machine as your investment would be recouped in a day and profitability would start on day two. I think we can also agree that you would not be willing to spend $5 million dollars on such a machine as you would need more than 13,600 years just to break even.  

The fair value certainly falls somewhere between these two price points.  For some, they may be willing to spend $1,000 and find they can recover their initial investment in 3 years.  Others may be only willing to spend $700, while still others might go as high as $1,500.  

The point is the exact fair price of the discounted daily dollar is up to the bidder of the device, but this is what makes markets.  As the seller of such a machine, I want to find the buyer willing to pay me the highest price.  As the buyer, I want to find the seller willing to sell at the lowest price.

Use Value

Use value is simply purchasing an asset and using this asset to provide me or my family with a service.  We purchase a house to provide us with a place to live and shelter us from the elements.  Houses do tend to increase in value, but it is the use of that home that people value most.  Besides, if we did not own our home, we would need to find shelter elsewhere and pay rent to provide that shelter.

Speculation

Speculation is not nearly as complex.  In this case, I purchase a Mickey Mantle rookie card, hold it for a while, and hope that someone is willing to offer me more (hopefully significantly more) than I paid.  This very famous baseball card does not shoot off income.  It simply sits….and waits.  It has no use-value (I cannot use the card for any functional purchase such as heating my home or feeding my children).  

These types of valuation methods are certainly oversimplistic but are a relatively simple way to help you understand how to value an asset.  

Stocks, bonds, annuities, businesses, or any asset class that either now, or at some point in the future shoots off cash, is usually valued as a discounted future cash flow asset.  Real estate and commodities (such as oil, coffee, or lumber) are often used assets.  Speculations can come in any form, but in today’s world, we see much speculation in cryptocurrencies, collectibles, and precious metals.  More traditional asset classes such as stocks and real estate can become speculations when prices of these assets become disconnected from their cash flow or use reality (i.e., eToys stock in 1999, real estate in 2006, and GameStop stock in 2021).

Even if a company, such as a technology company, that is losing money today or expects no free cash flow in the near future, it is still valued as an asset that is working to scale (grow) at such a quick rate it needs to burn a lot of cash now to stay ahead of the competition in a quickly changing and growing industry so someday it will be so large it will have significant cash to shoot off to its owners (shareholders).  Excellent examples of these types of companies are Amazon (lost money for 20 years before their profitability exploded), Facebook, Microsoft, Google, etc.  

Other companies such as Coca-Cola have little room for growth (the bushmen in Africa drink Coke) but they charge a very high price for sugared water thanks to the tremendous brand recognition they’ve built.  This means free cash flow is paid to the shareholders in the form of dividends in large quantities.

Historically, the valuation of a company or group of companies is measured by the price to earnings ratio (P/E) which tells investors how many years it will take you to make back your investment through earnings at the current rate (please note this metric does not account for growth over time of these earnings).  Historically, the S&P 500 has run at an average P/E ratio of 15-18 (It will take 15-18 years to make my money back at today’s earnings rate).  During times when markets have fallen and are low, P/E ratios can fall into the single digits.  During times like today and periods of strong economic growth and high speculation, P/E ratios can be in the mid-high ’20s.  For individual stocks like Tesla, the P/E ratio may be 1,500.

Experts tend to say an asset class like stocks are overvalued in markets like today’s environment when P/E ratios and metrics like them tell us that historically, this is the highest price in relation to earnings people have paid.  Investors are stretching to pay high prices for their money machine.  This does not mean necessarily that the markets will crash (although they can), however, it does mean that people will accept far lower returns over time when purchasing an asset today.  Unless they are bailed out by another buyer who is willing to accept even fewer returns in the future to pay a higher price today.  This, however, now becomes speculation and can be very profitable in environments like markets today…until it’s not.  When the music stops there will not be enough chairs for everyone.

There are far more metrics to consider than just P/E when trying to value an asset (such as current interest rates, the growth rate of earnings, future economic prospects, etc.). However, if you are simply purchasing an asset because it has gone up lately and hope someone else will purchase it from you in the future, understand you are a speculator, not an investor.  Many have become wealthy speculating just as many have won large sums of money at the roulette wheel.  However, luck plays a significant role in speculation and is not a solid long-term investment strategy.  The great investors throughout history have been successful in purchasing undervalued assets.

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Bonds: Should they be included in my portfolio?

By Bill Gallagher, CFP®, MPAS®

What is a bond?

A bond is a financial instrument that represents a loan from the investor to a government entity or a corporation. The majority of bonds today are issued by the U.S federal government, its agencies, municipalities, and U.S. corporations. There are two key features of bonds that differentiate them from other financial instruments:

  1. Regular coupon payments
  2. Maturity

When an investor purchases a bond, they are, in essence, lending their capital to the issuing entity. In return, the entity will pay the bondholder interest (either quarterly, semi-annually, or annually) for a stated period of time. At the end of that period the bond will mature, and the entity will return the bondholder’s original investment. The maturity of a bond can range anywhere between five to thirty years. While bonds have historically carried lower volatility than stocks, there are risks involved. Bondholders will find that they are exposed to default risk, interest rate risk, inflation risk, and reinvestment rate risk.

How can I purchase bonds?

There are two main ways in which an investor can purchase bonds:

  1. Purchase individual bonds
  2. Purchase a bond mutual fund or exchange-traded fund

Investors can purchase an individual bond through a broker or directly from the U.S. Government (in the case of a U.S. government bond). An investor may decide to purchase an individual bond if they were targeting a certain maturity date or stated level of interest. While an investor has the ability to purchase a variety of bonds it typically requires a large sum of money to build a well-diversified portfolio of individual bonds. Therefore, many investors choose to invest in a bond mutual fund or exchange-traded fund. A bond fund provides the investor with access to a diversified portfolio of bonds, with a lower initial investment. Before investing in a bond fund, it is important to be aware of the fees associated with the fund. In addition, it’s important to understand what type of bonds the fund is investing in. There’s a difference, in terms of risk, between investing in a short-term government bond fund (low risk) and a high-yield corporate bond fund (high risk).

Why should I include bonds in my portfolio?

Most people purchase bonds for interest payments. A retiree may want to invest a portion of her money in bonds so that she can use the interest payments to supplement her retirement income. However, bonds can also act as a ballast to the portfolio when you hit stormy seas. During periods of uncertainty and weak economic fundamentals, stock prices tend to decline. However, during these difficult periods bond prices tend to rise. The opposite is also true – when stock prices rise, bond prices tend to decline. Therefore, bonds can be used in combination with stocks, not only to create a diversified portfolio but to help reduce overall volatility (risk) and maximize the portfolio’s risk-adjusted return. This approach may also provide the investor with a more comfortable ride and not cause her to panic during periods of stock market declines.

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We have just passed the one-month mark since the stock market bottom and since that time, stocks initially had a compelling rally off the lows followed by a period of malaise as volatility collapsed and the market now churns sideways.

On behalf of the team at Zynergy Retirement Planning, we hope you, your family, and your loved ones are staying safe and healthy. I don’t think it needs to be said (but I’ll say it anyway) that we are living through extraordinary and unprecedented times. Our thoughts and prayers are with the sick and dying and the health care workers tending to them.

This post, although a brief market recap, is more of a greeting to let you know we are still here if you need us and to give you a few updates on the state of things.

As for the portfolios, we have done nothing since the lows of mid-March. Although unable to predict the future, I am growing more confident that the lows we saw during that time will be the market lows of this crises. It does not mean that volatility is behind us, we should all prepare for more market swings, but I don’t expect we will plunge below the mid-March levels.

We are also no longer making an aggressive call for cash. Unfortunately, the window of panic selling that led to extremely low valuations was relatively short-lived, not much more than a week or so. Many of you were able to take advantage of this opportunity which has proven very profitable. The rest will need to wait for the next opportunity, however, valuations at this level do not justify and aggressive push for additional cash.

Essentially, it is time to do what all great investors do most of the time….nothing. The portfolios have been rebalanced and are all exactly as they should be given the current environment and valuations. There is not much to do in the way of longer-term financial planning until we have more clarity on the fight against the Coronavirus. Essentially, we wait.

Our office remains closed while Lauren, Michela, and I continue to work remotely. Like most businesses, we have no idea when our office will open again but will certainly let you know when we do. Please know that the office number is being forwarded to Michela’s cell phone, so we are still receiving business calls to the office. However, the easiest way to contact us is via our cell phones.

We hope to see all of you again very soon. Until that time, stay safe and take the necessary precautions to ensure your health and the health of your family members. We will all get through this crisis together!

Please call Lauren or me if you would like to talk about your particular situation. We are here if you want to discuss your account, the market, or your financial plan. I am available on my cell at 732-822-9719 or at the office at 732-784-2380 as is Lauren (cell: 732-272-3348). As always, thank you for the faith you have placed in Zynergy.

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