It shouldn’t be a hard question to answer. But what I’ve discovered is that few investors even want to know the answer.

Why? Because most seem to care little about intrinsic value and are instead more interested in perceived value. The thought seems to be “As long as there’s a greater fool willing to buy my shares for more, it’ll work out in the end.”

That’s great wishful thinking. But it’s precisely the wrong way to approach investing. Both long-term investors and short-term traders ought to care about what they’re buying – whether they intend to hold forever or flip for quick gains.

Successful investors understand that stocks’ prices eventually follow their true value, although timing that convergence isn’t always easy. As Warren Buffett famously put it, “Price is what you pay; value is what you get.”

Not knowing (or caring) if an investment is underpriced or overpriced means making financial decisions in the dark.

But I assume, dear reader, that you are more thoughtful about your wealth than most – and neither afraid of nor apathetic to financial reality.

So… are stocks currently overvalued? Let’s find the answer.

One of the simplest ways most folks try to answer this question is by turning to a so-called price multiple. For example, the price-to-earnings (P/E) ratio – a stock’s price divided by its earnings per share – is widely used as a gauge of whether stocks are cheap or expensive.

Over 150-plus years, the S&P 500’s average P/E has been about 16. But right now, it’s about 72% higher at 27.6.

So it looks like we’ve gotten our answer. Stocks are overvalued. Plain and simple.

But we’re not quite done yet…

You see, while P/E is easy enough to understand, it’s not without flaws. In fact, it could be seen as oversimplifying the picture.

An alternative is Nobel laureate Robert Shiller’s cyclically adjusted price-to-earnings (CAPE) ratio, which factors in inflation and business cycles by using average inflation-adjusted earnings over 10 years.

The market’s current CAPE ratio of 34.2 is double its long-term average of 17. So just like P/E ratio, the CAPE ratio is telling us valuations are higher than they have been historically.

But unlike P/E, the CAPE ratio says something more…

Stocks aren’t just overvalued. They’re extremely overvalued.

In fact, the CAPE ratio has been this high only 4% of the time.

This should be alarming. But as I already noted, most retail investors and traders don’t seem to care as much about valuations as they used to. (It’s as if they can’t imagine a reason NOT to buy stocks.)

Given that so few care, do these extreme valuations really matter in the end?

Absolutely, yes.

History has repeatedly proven that there’s a true cost of overpaying for stocks: much, much lower long-term returns.

Even lower than those of risk-free assets.

Again, let’s turn back to the CAPE ratio.

Whenever the market’s CAPE ratio has topped 30, stocks have tended to underperform Treasurys over the subsequent 10-year period. (And, again, CAPE is currently near 35.)

Yes, you read that right. We’re talking about the highest-performing asset class in history underperforming the safest asset class in the world… by a wide margin.

Frankly, it’s embarrassing – especially when you consider how value-blind investors are these days. But it’s a lesson they’ll have to learn one way or another.

The bottom line is this: Never get comfortable overpaying as a stock investor. It comes with a huge – and totally avoidable – cost to your wealth in the long run.

Be thoughtful about your wealth, and always consider value.

Or else.

Be excellent,

Anthony

The post The Perils of Buying Overvalued Stocks appeared first on Wealthy Retirement.

I earned those high rates of interest for several years, and I came to expect them.

So when rates started to fall in the 2000s and banks and brokers began to pay as close to zero interest as they could, it was incredibly frustrating for me – as it was for all savers.

Today, the yield on the 10-year Treasury (a good proxy for interest rates) is a little more than half of where it was when I first ventured out into adulthood. So you’d think my Schwab account would pay somewhere around 2%, right?

Wrong!

Just as I’m still anchored to the 4% interest I received when I was young and impressionable, the banks and brokers are still intent on paying the nearly 0% interest they’ve been paying for the past 15 years or so.

My Schwab account pays me the princely sum of 0.45%. My bank pays even less. Suffice it to say, I keep very little cash in those accounts.

But that doesn’t mean there aren’t good income opportunities out there. You can earn 5% or more in some short-term Treasurys and certificates of deposit (CDs). Now, you do have to lock up your money for the full term, but it can be for very short amounts of time.

For example, you can earn 5.5% annualized on a one-month Treasury bill. And T-bills are liquid enough that you can sell them if you need to get your money out.

Of course, there’s no guarantee you’ll get all of your money back, as the bond’s price could fluctuate. But if you wait four weeks to get access to your funds, you are guaranteed to get all of your money back plus interest.

For those who are comfortable making longer-term investments in order to obtain higher yields and potential capital gains, corporate bonds are a great choice.

Right now, you can lock in a 5.4% yield on “A” rated corporate bonds for two years. These are extremely safe bonds.

If you go down to “BBB-” rated bonds, which are still investment-grade and very safe, you can earn as much as 7.4%. And if you’re willing to take on a bit more risk, you can earn more than 11% on some “BB-” rated bonds. (That’s at the high end of the range, but it is available.)

Plus, if economists and Wall Street are correct and the Fed lowers rates several times this year, bond prices will soar, because they move in the opposite direction of interest rates.

Bonds are in a sweet spot right now. If rates don’t move, bond investors will continue to receive their highest levels of interest in the past 15 years or so. And if rates fall, those higher yields will become even more valuable and bond prices will jump, offering the opportunity for even greater returns.

Life has gotten pretty expensive in the past few years. Savers and investors need every dollar working hard for them. We’re in a perfect environment for bonds to generate strong yields and potential profits.

If you don’t own any bonds, consider adding some to your portfolio today – whether they’re short-term Treasurys or higher-yielding corporates.

The post A Goldilocks Environment for Bonds appeared first on Wealthy Retirement.

Here are three of your favorites – enjoy!

The post Oil and Small Caps and Treasurys, Oh My! appeared first on Wealthy Retirement.

While I continue to hold dividend stocks for the long term, lately I’ve been putting most of my cash to work in fixed income.

Treasurys are yielding more than they have since 2007. Investment-grade corporate bonds – those with very safe S&P Global ratings of BBB- or higher – have an average yield of 6.3%, their highest yield in nearly 15 years.

Meanwhile, non-investment-grade bonds, or junk bonds, are yielding an average of 9%. While these are more speculative than investment-grade bonds, they are still more conservative than stocks – even blue chip stocks.

Here’s why…

There’s a very key difference between stocks and bonds.

A stock is worth only what someone is willing to pay for it at a given time.

A bond is worth $1,000 at maturity regardless of what anyone is willing to pay for it at any time.

Here’s what I mean.

When you buy a stock, the only way to make money on it is to sell it for more than you paid. When you want to sell the stock, you have to hope the price is higher than it was when you bought it.

With a bond, you know what the exact price of the bond will be on a certain future date. On the bond’s maturity date, you will receive $1,000 unless the company has gone bankrupt. Barring that unlikely scenario, you will get $1,000, regardless of whether you paid $1,000, $900 or $500 for the bond. You’ll also collect interest along the way.

It’s important to realize that even if the price of the bond falls while you own it, that won’t affect your eventual payout. At maturity, you will be paid $1,000.

So let’s say you buy a bond with a 5% coupon that matures on November 1, 2026. Right after you buy the bond, the company posts bad news and the bond drops to $950. A year later, there’s more bad news, and the bond market starts getting scared. Your bond drops all the way to $700, which is a big move in the bond market.

As we approach November 1, 2026, the bond’s price starts moving closer to the $1,000 mark. On that date, the bond matures and you are paid $1,000. It doesn’t matter that the market lost confidence in the bond two years earlier and the bond was trading at a huge discount. The bond will pay $1,000 at maturity no matter what.

The stock market has been a mess for two years. The S&P 500 is up this year, but that’s mostly due to seven Big Tech stocks. Most stocks in the market are down… and many are down big.

And this bear market shows no signs of slowing down in the near future.

When you can earn more than 5% risk-free in the short term in Treasurys, more than 6% in safe corporate bonds or even 9% in more speculative bonds and get your money back, you have to ask yourself whether it’s worth it to risk your cash in stocks, which historically average a return of 8% to 10% per year but involve much more volatility.

My long-term money is still invested in stocks because I (hopefully) have plenty of time for those stocks to grow. But my funds that I’ll need in the shorter term are in bonds right now.

I have a bunch of bonds maturing between now and the end of the year, and I’m excited about the safe income-producing opportunities we have now that weren’t available just a year ago.

You rarely hear someone pounding the table on bonds.

I am.

The post Today Is the Perfect Day to Buy Bonds appeared first on Wealthy Retirement.

Early in my career, I was briefly taking my U.S. dollar paychecks and converting them into Canadian dollars at an exchange rate of 1.6 to 1. That meant that for every $1 I was paid, I was actually receiving $1.60 in my home currency.

For a young man just starting his career, it was fantastic!

Five years later in 2007 though, my currency bliss was gone.

Then, on the back of $100-per-barrel oil, the Canadian dollar was trading at a premium to the greenback. For each $1 I was paid in U.S. dollars, I received only $0.93 in loonies.

Despite receiving two promotions, I was making significantly less money in Canadian dollars in 2007 than I was in 2002.

Because of the financial impact that U.S. dollar movements have on me, I’ve studied the U.S. dollar more closely than virtually anyone I know.

What I can tell you after 20 years is that most of the time, predicting where it is going to go is exceptionally hard.

Every day, more than $5 trillion changes hands in the currency markets, and more than $4 trillion of those trades involve the dollar.

But I can tell you one thing with certainty…

When investors are afraid, it is easy to predict what the U.S. dollar is going to do. The more fearful investors are, the stronger the dollar is.

And when the fear subsides, so too will the dollar.

That is exactly what is happening today…

Economies Are Reopening… Fear of a Depression Is Gone

Investor sentiment hit maximum fear over COVID-19 the week of March 20.

That week, I watched a movie with my kids, but I have no recollection of the plot. My mind was too busy thinking about how to keep my family safe if the outbreak got out of control in our city.

I was afraid.

At that point, none of us had any idea what the next 18 months were going to look like.

When fear hits, the U.S. dollar surges. When people are afraid, they feel better owning American assets, specifically U.S. Treasurys.

On March 19, when fear was at its highest, the U.S. Dollar Index peaked at 102.87.

Since that point of maximum fear, the dollar has weakened as the truly worst-case coronavirus projections have been taken off the table.

The dollar decline was steady at first, and then it became much more rapid.

The U.S. Dollar Index now sits below 97, posting a sudden 3% decline over the past two weeks. Those numbers might not feel significant, but they are big moves in currency land.

But I thank goodness the dollar has weakened so quickly. It tells us that things are getting better.

Which Companies Benefit From a Weakening Dollar?

A strong dollar tends to push down commodity prices, slow growth in emerging markets, put a damper on inflation in the U.S., and make American goods and services less competitive in the global market.

This is because everything priced in U.S. dollars becomes more expensive as the dollar strengthens.

A weak dollar does the opposite…

A weak dollar stimulates demand for commodities, increases import prices (making domestic goods and services more competitive) and stimulates demand for American-made products, which increases inflation.

If you are an investor who has exposure to the S&P 500, you are already a big beneficiary of a weakening dollar. Analysts estimate that somewhere between 40% and 50% of S&P 500 sales are from abroad.

Here are the specific sectors that benefit the most from a declining dollar…

Technology: According to Thomson Reuters data, roughly 60% of S&P 500 tech revenue comes from overseas. Apple (Nasdaq: AAPL), IBM (NYSE: IBM) and Microsoft (Nasdaq: MSFT) all fit the bill here.

Industrials: These companies make products that are used worldwide. As the dollar drops, their products become cheaper for international buyers. For example, Caterpillar (NYSE: CAT) regularly outperforms when the dollar weakens.

Energy and materials: When the dollar drops, commodity prices tend to rise. Oil majors like Exxon Mobil (NYSE: XOM), Chevron (NYSE: CVX) and Royal Dutch Shell (NYSE: RDS-A) all get a cash flow boost.

The U.S. dollar has already had a pretty big move in recent weeks, so it might hold steady for a while. Not to worry, though – if you hold a diversified portfolio of S&P 500 stocks, you’ve already benefited from the dollar’s recent move.

Good investing,

Jody

The post How to Play a Weaker Dollar appeared first on Wealthy Retirement.

Typically, after a meeting, the Fed will make three moves…

First, it will issue a brief statement, which it did last Wednesday.

Then, periodically, the chairman – currently Jerome Powell – will have a press conference. But we got no press conference from the Fed last week.

Finally, the month after the meeting, the Fed minutes will be issued.

These three forms of communication are some of the most closely parsed words in the world.

But when a Fed chair is new, they sometimes make rookie mistakes.

For example, then-Fed Chair Ben Bernanke, who shepherded the economy through the Great Recession and was given credit for keeping the banking system afloat, famously made comments to Fox Business News anchor Maria Bartiromo at a cocktail party in 2006, thinking the comments were off the record.

Little did he know that she would turn around and report his comments to the world…

Current Fed Chair Powell hasn’t, in my estimation, made any rookie mistakes like that.

The closest he has come was at the end of 2018 when he said that the Fed would continue with its multiyear rate hike campaign. But the markets clearly wanted to hear that the Fed would stand ready to cut rates if necessary.

Powell’s comments led to the worst December 2018 equity market performance since the Great Depression. Powell and the rest of the Fed members learned their lesson and promptly began pushing the “Fed pivot,” which led to three rate cuts in 2019.

After a slip of that scale, it’s clear that the statement we received on Wednesday was very carefully worded – so some specific choices caught my attention.

Carefully Chosen Words From Last Wednesday’s Fed Meeting

The Fed left rates unchanged at the Wednesday meeting, keeping the federal funds rate at a range of 1.5% to 1.75%. However, it did make two language changes that caught my eye.

The first: The committee changed language to say we were “returning to 2%” inflation instead of “near 2%” inflation in the December statement, indicating that the Fed might act more aggressively in the future to help push inflation higher.

In order to do this, it would need to cut rates or discontinue the current balance sheet expansion – or both. This slight change in phraseology opens the door for the Fed to do that.

The other notable change in the statement is that the Federal Open Market Committee now sees household spending rising at a “moderate” pace. It previously saw “strong” spending growth.

This slightly nuanced change indicates that the committee doesn’t see consumer spending as strong as it previously did. This also gives the Fed some wiggle room to cut rates in the future, discontinue its current balance sheet expansion or both.

Will the Fed Cut Rates in 2020?

I’m still in the camp that believes we won’t see more rate cuts this year – primarily because the Fed doesn’t want to be part of the debate in the presidential election.

The recent novel coronavirus, however, has prompted huge demand for the safety of U.S. Treasurys, and with that demand, bond prices have risen and yields have plummeted.

A slice of the U.S. Treasury yield curve inverted last Thursday, which of course is a sign that the economy may be tipping toward recession.

For bond investors, though, this shouldn’t create panic…

Our tried-and-true strategy of staggering maturity dates and diversifying across sectors – choosing our bonds as carefully as Jerome Powell chooses his words – will keep our portfolio steady and maintain our income even if the economy slips.

Good investing,

Rob

The post Reading Between the Lines of Last Week’s Fed Meeting appeared first on Wealthy Retirement.