Bitcoin – There’s No There There

Bitcoin – There’s No There There

by | Sep 29, 2022 | Learning, Most Popular

The Big Guys Move In

On September 13, 2022, the biggest of the big guys on Wall Street came out with a rather earth-shaking announcement. None other than Fidelity, Citadel Securities, and Charles Schwab have launched a new cryptocurrency exchange. In the words of the press release:

“A consortium of leading broker-dealers, global market makers and venture capital firms today announced the launch of EDX Markets (EDXM), a first-of-its-kind exchange that will address latent demand for digital asset trading by enabling safe and compliant trading of digital assets through trusted intermediaries. The new exchange will combine proven technology provided by MEMX with best practices from traditional financial markets and tighter spreads enabled by greater liquidity, to support secure, fast and efficient cryptocurrency trading for U.S. retail and institutional investors.”[i]

Jamil Nazarali, the new CEO of EDX Markets and former global head of business development at Citadel Securities, had this to say (and I’m fairly certain he meant virtual and not virtuous, although it might have been Freudian slip):

“We look forward to welcoming additional participants to the exchange, which will drive ongoing trading in this important asset class while creating a virtuous cycle of continually enhanced liquidity and efficiency supported by MEMX’s cutting-edge technology.”[ii]

The Upshot of All This?

A massive amount of sideline money is about to be invited into the world of Bitcoin and other cryptocurrency.

In my view, the results will be catastrophic, for according to many respected voices in the world of finance, there just isn’t any there there.

Just What the Heck Is Bitcoin Anyway?

It’s really an ingenious system. In 2009, an anonymous person or persons named Satoshi Nakamoto wrote a White Paper explaining a new, complex form of digital currency. In the White Paper, you’ll find some relaxing reading that looks like this;

“∑ k=0 ∞  k e − k! ⋅{ q/ p z−k  if k≤z 1 if kz} Rearranging to avoid summing the infinite tail of the distribution… 1−∑ k=0 z  k e − k! 1−q/ p z−k”

Read the entire White Paper here.  It’s only 9 pages.

Now this complex system would have to be supported on powerful computers. They cost money. Why would anyone donate computer power to this system? Because Nakamoto created a computer network that would produce “coins” that owners of the computers would automatically receive if they added “blocks” to the blockchain that is Bitcoin. Yes, Bitcoin is one large and growing blockchain that generates coins with each additional block created.

What’s a “block”? Well, it’s a unit of data. In the Bitcoin blockchain, a block can contain only 1 MB of data, which is enough to store 2,000 transactions.[iii] Actually, after an upgrade to the Bitcoin protocol called “Segregated Witness” the size of the blocks is larger, for they are now measured in block weight and not block size.

These blocks “are linked using cryptography. Each block contains a cryptographic hash of the previous block, a timestamp, and transaction data. A blockchain is a decentralized, distributed and public digital ledger that is used to record transactions across many computers so that the record cannot be altered retroactively without the alteration of all subsequent blocks and the consensus of the network.”[iv]

And what’s a “cryptographic hash”? Way above my paygrade, but I can show you one. Try this on for size:

38FC4D3E1531D7661A4E32F4B6AE9EF9238DA753F485F17401140B2504A6012B

So when a miner crunches millions of calculations involving transaction hashes and Lord know what else to prove that the data in a block is verified and can’t be changed, the blockchain grows by one block, the miner gets 6 or so Bitcoins, and the process continues―in feverish computers across the globe.

Nakamoto knew that for computer owners to agree to offer their computer power to hold up this potentially enormous computer network, they’d have to be paid. And the coins they would receive for “mining” had to have value. How would they be valuable? If masses of people would buy the coins by moving real money into the pockets of those who would sell them Bitcoins, then the coins would have value.

And that’s what happened. In a very big way. In the early years, you could buy Bitcoin for pennies. In fact, on May 22, 2010, “Laszlo Hanyecz made the first recorded purchase of a physical good using Bitcoin. He spent 10,000 Bitcoin to purchase two Papa John’s pizzas …. Since Papa John’s didn’t accept Bitcoin as payment, he posted a 10,000 Bitcoin offer on Bitcointalk.org and Jeremy Sturdivant, a 19-year old then, took the offer, … bought the two pizzas, and delivered.”[v]

The pizzas cost Jeremy $41. So $41 divided by 10,000 yields an 2010 price of Bitcoin at $.0041 or four tenths of one penny. And how on earth would Laszlo Hanyecz “send” 10,000 Bitcoins to Jeremy? They aren’t, after all, physical coins. They are nothing more than computer code.

Today, if you want to send someone some Bitcoin, you just ask them for their “receive” address. Do you have to send an entire Bitcoin, which is worth around $19,000? No, Bitcoin can be divided into 8 decimal places. In fact, the smallest Bitcoin unit is .00000001 and it’s call “one Satoshi,” named after the anonymous founder.

To receive Bitcoin today, you’d just provide your Bitcoin “address.” Here’s one. It’s real and the owner would love for you to send Bitcoin to it:

3P2awwGe7kpEQgyAiw6vupHJ9vKvtJRJqb

So today, there are hundreds of thousands of computers holding up this vast computer network. They “mine” Bitcoin, which they either keep (hoping for a higher price) or sell (to cover their expenses). Who buys these Bitcoins? Millions of people around the world.

How Many People Own Bitcoin?

People buy cryptocurrency by setting up an account with an exchange―like the new exchange coming from Fidelity, Citadel, and Schwab. As of July 2022, more than 83 million people had created accounts on Blockchain.com. Coinbase, one of the most popular exchanges, has 98 million users. Crypto.com has 50 million customers. The Binance exchange has over 25 million customers. Those are the major exchanges with 256 million customers.

Now, all those people don’t own Bitcoin. They own other cryptocurrencies. Which ones? Who knows. Motley Fool estimates the total at 12,000:

“There are now more than 12,000 cryptocurrencies, and what’s truly astonishing is the growth rate. The number of cryptocurrencies more than doubled from 2021 to 2022. At the end of 2021, the market was adding about 1,000 new cryptocurrencies every month.

“This isn’t entirely good news. Many new cryptocurrencies have little purpose other than making money for their developers, which means investors need to be selective. Only a small portion of cryptocurrencies are worth learning about and potentially buying.”[vi]

With all these computers holding up thousands of crypto coins, they share one thing in common. Their lifeblood is electricity.

Strike One Against Bitcoin: Electricity Consumption

In Bitcoin’s early years, miners used general-purpose graphics processing units (GPUs) and field-programmable gate arrays (FPGAs). But in 2012, the first application-specific integrated circuits (ASICs) came on the scene. In the words of Cambridge Bitcoin Electricity Consumption Index:

“ASICs are specialised hardware specifically optimised for Bitcoin mining that are orders of magnitude more efficient than previous devices used for mining. As a result, it did not take long for ASICs to dominate and eventually displace GPU and FPGA mining.”[vii]

Today, mining Bitcoins eats up an incredible amount of electricity. According to the New York Times:

“The process of creating Bitcoin to spend or trade consumes around 91 terawatt-hours of electricity annually, more than is used by Finland, a nation of about 5.5 million.”[viii]

According to recent studies, the increased energy consumption attributable to Bitcoin mining threatens “the ability of governments across the globe to reduce our dependence on climate-warming fossil fuels. If we do not take action to limit this growing industry now, we will not meet the goals set forth by the Paris Agreement and the Intergovernmental Panel on Climate Change to limit warning to 2°C.”[ix]

Earthjustice and the Sierra Club wrote a new guidebook that “comprehensively document[s] the explosive growth of cryptocurrency mining in the United States and examine[s] how this industry is impacting utilities, energy systems, emissions, communities and ratepayers.”[x]

Bitcoin Goes BOOM!

The Guidebook is entitled;  The Energy Bomb: How Proof-of-Work Cryptocurrency Mining Worsens the Climate Crisis and Harms Communities Now. In the Guide, you’ll find vast amounts of information, not just about Bitcoin and air pollution but also about … noise pollution. Consider these local concerns:

“Neighbors have reported [various horror stories].

“At a mining facility in Limestone, Tennessee, residents have described the noise as ‘like a jet engine idling on a nearby tarmac.’ A commissioner who voted to approve the operation told a reporter that he has ‘never regretted a vote like this one. I sure wish I could take it back.’

“In Cherokee County, North Carolina, residents offer that the noise is ‘like living on top of Niagara Falls’ and ‘like sitting on the tarmac with a jet engine in front of you. But the jet never leaves. The jet never takes off…. It’s just constant annoyance.’”[xi]

Strike Two: Computers Are Thrown Away

As new computers become faster and more efficient, Bitcoin miners must buy new equipment. Their ASICs are primarily designed for Bitcoin mining, so when better equipment becomes available, they just junk existing systems. There’s a name for that: e-waste. And the amount of waste is significant. Again, the Times:

“Bitcoin mining means more than just emissions. Hardware piles up, too. Everyone wants the newest, fastest machinery, which causes high turnover and a new e‑waste  problem. Alex de Vries, a Paris-based economist, estimates that every year and a half or so, the computational power of mining hardware doubles, making older machines obsolete. According to his calculations, at the start of 2021, Bitcoin alone was generating more e-waste than many midsize countries.

“‘Bitcoin miners are completely ignoring this issue, because they don’t have a solution,’ said Mr. de Vries, who runs Digiconomist, a site that tracks the sustainability of cryptocurrencies. ‘These machines are just dumped.’”[xii]

Strike Three: Just What Exactly Do You Own?

Jamie Dimon, the CEO of JP MorganChase, has his opinion of Bitcoin. He doesn’t hold back.

“Jamie Dimon didn’t mince words when a US lawmaker mentioned the executive’s history of criticizing cryptocurrencies.

‘‘I’m a major skeptic on crypto tokens, which you call currency, like Bitcoin,’ the JPMorgan Chase & Co. chief executive officer said in congressional testimony Wednesday. ‘They are decentralized Ponzi schemes.’”[xiii]

If you own a share of stock, you own part of a company. That company earns money. That company might own real estate. It might have valuable patents and trademarks. It might have a boatload of cash in its coffers. You own part of that.

Now you don’t have to own 1 Bitcoin to own cryptocurrency. You can buy $100 or even $1.00 worth of Bitcoin (the coin is divisible to 8 decimals).

So if you own $100 of Bitcoin, you own …. What? You own the ability to sell it or to send it to someone else. If you sell it, you hope the price has risen. So why is it worth anything?

“‘The reason why it’s worth money is simply that we, as people, decided it has value—same as gold,’ says Anton Mozgovoy, co-founder & CEO of digital financial service company Holyheld.”[xiv]

But it differs from gold. You can hold gold in your hand. But you can only “hold” Bitcoin in a crypto wallet or in a crypto exchange account … like the ones that Fidelity, Schwab, and Citadel are about to loose on the world.

When that exchange goes live, it will make the purchase of Bitcoin and other cryptocurrencies a great deal easier. And that will attract potentially millions of new people betting their hard-earned savings on what the esteemed Mr. Dimon calls a “Ponzi Scheme.”

The volatility of Bitcoin is notorious. It reached its all-time high (ATH) of $69,045 on Nov. 10, 2021. It’s price on Sept. 24, 2022, was $19,091. Those who buy today hope it reaches the ATH once again. Those who bought 1 Bitcoin at the ATH are nursing a $49,954 loss. That’s a 72% loss, leaving you with just 28% of what you started with. To recover all you lost, it will need to increase 257% to get back to its ATH. Not an easy task.

So Mr. Dimon has his opinion.

I have mine.

Bitcoin and all its relatives are going to end up as the world’s largest financial fraud.  I am disappointed that Schwab has agreed to be part of this scheme. The reasons for the massive popularity of Bitcoin are several:

Ignorant Investors

Ill-informed speculators, especially those under 45, are rolling the dice, and don’t have a clue what it really is. It’s worse than betting at the Las Vegas Blackjack Tables.

Criminal Use

There is no doubt that Bitcoin has been used by criminals around the world to move money. There’s also no doubt that hundreds of millions of dollars have been stolen through various cryptocurrency frauds. Even though governments are having some success in tracking down crypto criminals,[xv] the fact remains; you can move millions of dollars anonymously with Bitcoin.

Market Manipulation

Watch out for the Whales.

The what?

The Whales.

In the world of Bitcoin, a Whale is a person, group of people, or organization that owns more than 1,000 Bitcoins (around $19 million at today’s prices). Whales have a huge amount of power over the crypto market. On April 2, 2019, for example, a single order for 20,000 Bitcoins was executed on three exchanges. The price jumped from $4,200 to $5,000 in just two hours. This single purchase triggered a change in sentiment. Bitcoin’s price increased 240% by the end of June.[xvi]

An even more telling Whale activity occurred in the spring of 2021. The chart below, from glassnode,[xvii] shows what happened. The red line shows the number of addresses holding 1,000 or more Bitcoins (Whales). The green line shows the number of addresses holding 0.01 or more Bitcoins (retail traders, that is, Krill). The gold line shows Bitcoin’s price. As you can see, in the middle of February Whales began selling their Bitcoins to those with small accounts as the price continued to rise. Then, the bottom fell out. Whales made millions. The little guys lost.

Bitcoin has been languishing throughout the summer of 2022. It’s stuck in a bear market. But since Bitcoin hit the investment scene, it’s toggled between bull markets and bear markets. When the next bull market hits, the Whale will once again feast off the Krill―the little buys. See real whales feast here.

YouTube Influencers

Fortunes can be made by creating a successful YouTube Channel. In crypto, scads of influencers make hundreds of videos―many viewed by hundreds of thousands of eager crypto investors. Here’s a sampling, one taunting “insane potential” of “six coins set to explode”:

Meet Carl “The Moon” Runefelt

This young man from Sweden went from store clerk to Bitcoin billionaire. He posted his first YouTube video in December 2017 and now has 550,000 subscribers and over 70 million views.[i] He currently lives in a penthouse condo in Dubai.[ii]

Most crypto YouTubers have arrangements with various exchanges. Carl The Moon, for example, urges viewers to use bybit.com and to click a link right there on his YouTube page.[iii] Of course, when ByBit receives new accounts through the clicking of this link, Carl gets a commission. Now there’s nothing wrong with that. But he also often urges viewers to take on leveraged positions, sometimes 10 times leverage.

And that can spell disaster for retail investors.

Leveraged Trading Can Lead to Disaster

You can learn a lot about leveraged trading in this Coin Bureau video (you just have to ignore the silly introductions these videos often have). CoinBureau has more than 2 million subscribers, and it does produce reasoned, no-hype analysis.

On this video, you’ll learn that Futures contracts in the crypto world are provided by off-shore operations and they are totally unregulated. These contracts can offer up to 100x leverage. The danger is quite evident. In this video, CoinBureau analyzes the danger that leveraged trading poses for the crypto markets (and for retail investors). In the video, CoinBureau cites a Carnegie-Mellon study of Futures offered on the BitMex exchange.[iv] You’ll find the video fascinating and the Carnegie-Mellon study compelling.

The Need for Regulation

I’m not sure if coming regulation will save the day for the crypto market. I still maintain that there’s no there there. Crypto has value, just as the tulip buyers in the 1600s thought that tulip bulbs had value. “At the market’s peak, the rarest tulip bulbs traded for as much as six times the average person’s annual salary.”[v]

The White House recently released a “Framework for Responsible Development of Digital Assets.” Its Fact Sheet emphasize the risks that investors face when they play around with these “decentralized Ponzi schemes,” to borrow Jamie Dimon’s words:

“Digital assets pose meaningful risks for consumers, investors, and businesses. Prices of these assets can be highly volatile: the current global market capitalization of cryptocurrencies is approximately one-third of its November 2021 peak. Still sellers commonly mislead consumers about digital assets’ features and expected returns, and non-compliance with applicable laws and regulations remains widespread. One study found that almost a quarter of digital coin offerings had disclosure or transparency problems—like plagiarized documents or false promises of guaranteed returns. Outright fraud, scams, and theft in digital asset markets are on the rise: according to FBI statistics, reported monetary losses from digital asset scams were nearly 600 percent higher in 2021 than the year before.”

Conclusion

You and everyone in the securities industry knows that Schwab has a terrific trading platform. It’s obvious the public―maybe even you―wants access to crypto and thus Schwab, Fidelity, and Citadel are jointly offering this easier trading platform to attract millions of small investors (Krill). In my opinion, they’re also attracting Whales.   

Do you disagree with the statement, “The larger the school of Krill, the more the Whales can feast”?

The Whales are salivating.

Just waiting for this new, huge school of Krill to swim their way.

 You’d be wise to be very careful of the waters in which you and your young adults swim.

[1] https://www.businesswire.com/news/home/20220913005367/en/

[1] https://bitcoinmagazine.com/business/fidelity-citadel-securities-charles-schwab-launch-crypto-exchange

[1] https://www.bitstamp.net/learn/crypto-101/what-is-block-size/

[1] https://www.synopsys.com/glossary/what-is-blockchain.html#:~:text=A%20blockchain%20is%20%E2%80%9Ca%20distributed,a%20timestamp%2C%20and%20transaction%20data.

[1] https://www.forbes.com/sites/rufaskamau/2022/05/09/what-is-bitcoin-pizza-day-and-why-does-the-community-celebrate-on-may-22/?sh=1963c34fd685

[1] https://www.fool.com/investing/stock-market/market-sectors/financials/cryptocurrency-stocks/how-many-cryptocurrencies-are-there/#:~:text=There%20are%20now%20more%20than,1%2C000%20new%20cryptocurrencies%20every%20month.

[1] https://ccaf.io/cbeci/index/methodology

[1] https://www.nytimes.com/interactive/2021/09/03/climate/bitcoin-carbon-footprint-electricity.html

[1] https://earthjustice.org/features/cryptocurrency-mining-environmental-impacts

[1] https://earthjustice.org/features/cryptocurrency-mining-environmental-impacts

[1] https://earthjustice.org/sites/default/files/files/2570_bitcoin_white_paper_04_nt.pdf

[1] https://www.nytimes.com/interactive/2021/09/03/climate/bitcoin-carbon-footprint-electricity.html

[1] https://www.bloomberg.com/news/articles/2022-09-21/dimon-calls-out-cryptocurrency-as-decentralized-ponzi-schemes?leadSource=uverify%20wall (emphasis added)

[1] https://www.forbes.com/advisor/investing/cryptocurrency/what-is-bitcoin/

[1] https://www.science.org/content/article/why-criminals-cant-hide-behind-bitcoin

[1] https://www.okx.com/academy/en/crypto-whale-transaction-analysis-ways-to-monitor

[1] https://www.okx.com/academy/en/crypto-whale-transaction-analysis-ways-to-monitor

[1] https://techiegamers.com/themooncarl-net-worth/

[1] https://techiegamers.com/themooncarl-net-worth/

[1] https://www.youtube.com/watch?v=RnKJ0rnx7e4

[1] https://www.cylab.cmu.edu/_files/documents/towards-understanding-cryptocurrency.pdf

[1] https://www.investopedia.com/terms/d/dutch_tulip_bulb_market_bubble.asp

EVs―The Next Big Thing

EVs―The Next Big Thing

by | Aug 22, 2022 | Learning, Most Popular

EVs―The Next Big Thing

An Interesting Email

We recently received an interesting email from a reader of our RFS website. Katie Griffin is a Senior Communications Specialist at EcoWatch.org, a group devoted to disseminating information on the environment to help reduce carbon emissions and their deleterious effects on the atmosphere. Turns out that Ms. Griffin read our article about Lithium,[i] which we sent to clients and friends in August of 2021.

In her email, Ms. Griffin wrote:

I wanted to reach out because I saw that you have some great information about electric cars on your page. It’s projected that there will be 18 million electric vehicles on U.S. roads by 2030. As EV’s grow in popularity, it’s important that people are aware of the different types, their impact on the environment and the pros and cons of purchasing one. 

EcoWatch.org, which has a Twitter following of 238,000, recognized the growing popularity of electrical vehicles and as a result created a guide called “Electric Vehicles 101: Everything You Need to Know.” It’s a must-read for anyone wanting to buy, or just interested in, an EV. You may find the guide here. 

Yes, Everything

The EcoWatch guide kid you not: It does indeed have everything you need to know about EVs.

  • History: Did you know that in 1900 one-third of all vehicles on the road were electrical vehicles?
  • Types of Electrical Vehicles: HEVs, PHEVs, BEVs, … the alphabet’s heyday.
  • Are EVs Better for the Environment: yes, says the Guide. Some interesting facts here.
  • How Long Does It Take to Charge an EV’s Battery: In the Guide, you’ll find not only “how long” but “where”; you’ll discover ‘Plugshare, a free website and phone app that bills itself as ‘the most accurate and complete public charging map worldwide, with stations from every major network in North America and Europe.’”
  • Cost of Charging an EV: About half the cost of a combustion-engine car, says the Guide (assuming gas at $3.00 per gallon―so these days less than half).
  • Uncle Sam Wants You (to buy an EV): The Guide covers the federal tax credits you can enjoy when you buy an EV …but …

Inflation Reduction Act (IRA) Changed All That

The recently enacted Inflation Reduction Act made significant changes to the federal tax credits available to EV buyers. According to CBS News:

President Biden’s signing of the Inflation Reduction Act is changing the landscape for Americans interested in buying an electric vehicle. The law replaces a previous tax break for EVs with a new set of credits, although that depends on where a car is assembled.

The manufacturing requirements are effective as of August 16, 2022, the day the bill became law. Other restrictions, including strict limits on where batteries can be mined and assembled, kick in starting in 2023 and ramp up in future years.[ii]

The IRA requires assembly of EVs in North America before federal tax credits are available. It also restricts battery mining and assembly to certain locations. To make certain your prospective EV qualifies, you can check it against this list provided by the Department of Energy.

CBS News provides the following list of eligible cars:[iii]

2022 models that likely qualify for a tax credit under the Inflation Reduction Act

  • BMW 330e and X5
  • Chrysler Pacifica PHEV
  • Ford F Series
  • Ford Escape PHEV and Mustang MACH E 
  • Ford Transit Van
  • Jeep Grand Cherokee PHEV and Jeep Wrangler PHEV
  • Lincoln Aviator PHEV and Corsair Plug-in
  • Lucid Air
  • Nissan Leaf
  • Rivian EDV, R1S and R1T
  • Volvo S60

2023 models that likely qualify:

  • BMW 330e 
  • Mercedes EQS SUV
  • Nissan Leaf

You might notice that the list omits the most popular EVs sold in America; Chevrolet Bolt EV and EUV; GMC Hummer Pickup and SUV; and Tesla Model 3, Model S, Model X and Model Y vehicles. Even though these cars are assembled in America, their manufacturers have exceeded a sales cap under a previous law. This cap will be lifted in 2023, so if you’re shopping for an EV, you should include the popular models on your shopping list.

We’re On It

Only in the past four years have investors had the opportunity to invest in ETFs “specifically dedicated to driverless cars, electrical vehicles. and other innovations in the automobile industry.”[iv] For our Aggressive Growth Model, we selected DRIV.[v] The managers of this ETF―Global X―describe their overall philosophy in creating more than 60 ETFs:

A lineup that spans disruptive tech, equity income, hard-to-access emerging markets, and more. Or simply put, we strive to offer investors something beyond ordinary.[vi]

About the DRIV ETF, the managers have this to say:

EVs produce zero direct emissions, meaning broader adoption could result in reduced greenhouse gas emissions and improved urban air quality. Further advances in autonomous driving could also enhance roadway safety.

No One Knows

Who knows how far and how fast EVs will advance in the marketplace. With groups like EcoWatch (and, no doubt, hundreds more) supporting the transformational change to electrical vehicles and with the federal government eager to pay American citizens to buy them, it seems rational to conclude that investments like DRIV will do well in this decade.

But who knows where the overall stock market is heading. We’ve positioned our Aggressive Growth Model in a decidedly short position with the large 3x short position in SQQQ we bought on August 17, 2022. Counterbalancing this position are TQQQ and UPRO 3x long positions. When the market reveals its hand, we’ll sell either the short position (if the market is heading up) or the long position (if the market is heading down) and just ride in the direction our analysis takes us.

Call Us

As always, please call us at 301-294-7500. We are happy to answer any questions you have.

And please forward this email to family, friends, and colleagues―they, too, might be in the market for an electrical vehicle and would appreciate having access to EcoWatch’s EV Guide.

[i] https://www.rfsadvisors.com/lithium/
[ii] https://www.cbsnews.com/news/inflation-reduction-act-ev-credits-electric-vehicle-2022/
[iii] https://www.cbsnews.com/news/inflation-reduction-act-ev-credits-electric-vehicle-2022/
[iv] https://www.investopedia.com/articles/etfs-mutual-funds/050216/3-etfs-take-advantage-driverless-car-revolution-carz-arkq.asp?utm_campaign=quote-yahoo&utm_source=yahoo&utm_medium=referral
[v] https://www.globalxetfs.com/funds/driv/
[vi] https://www.globalxetfs.com/explore/

Pinching Pennies, Pensions, and 401k’s

Pinching Pennies, Pensions, and 401k’s

by | Aug 8, 2022 | Learning

Tough Times

When times get rough, the natural human urge becomes one of extreme frugality. Certainly those who survived the Great Depression developed various habits prompting others to view them as “penny pinchers.”

Well, today, those sitting atop the financial infrastructure―companies, governments, and other organizations that sponsor ginormous pension funds and 401k plans―have begun to feel the pinch―perhaps not the pinch of pennies but certainly the pinch of nerves.

40% Are “Nervous”?

Pension and 401k plans are underperforming. When massive amounts of money are set aside to fund the retirement of employees, the sponsors of those plans set their sights on a certain rate of return. The planners know how many years the average pension recipients have before they slip off the raft and can thus figure out how much the average plan participant needs to live a decent life. A certain rate of return―together with Social Security and personal investments―will produce that level of income.

But what happens when the rate of return fails to materialize? The S&P 500 Index was created in 1957. For 64 years―until Dec. 31, 2021―the S&P returned an average of 10.67%.[1] But so far this year, the S&P is down -2.82% in price. When .77% in dividends are added in, the net return this year is negative -12.05%.[2]

To find out how plan sponsors were coping, Cogent Syndicated, a division of Escalent, “conducted an online survey of a representative cross section of 1,267 401(k) plan sponsors from February 11 to March 8, 2022. Survey participants were required to have shared or sole responsibility for plan design, administration or selection and evaluation of plan providers, or for evaluating and/or selecting investment managers/investment options for 401(k) plans.”[3]

40%? Yes, Almost

The war in Ukraine and market volatility have frightened nearly 40% of those surveyed. According to the survey, “nearly four in ten (37%) plan sponsors expect domestic marketplace conditions to worsen, up from 20% in 2021.”[4] 

Nearly 60% Fear Underperformance

The fear factor increases when plan sponsors were asked about the ability of their 401k’s or pensions to meet performance targets. “Concern about underperformance of plan investment options continues to grow with 57% of plan sponsors concerned in 2022, increasing by 6% since 2021.”[5]

What to Do?

Perhaps the 401k or pension just cannot meet initial targets. After all, the plan cannot create returns out of thin air. It becomes perfectly plain that plan recipients will have to reduce their expectations and take affirmative steps to make ends meet. Recipients just might have to learn those money-saving steps that served our forbears so well in the 1930s. Even pinching pennies comes to mind.

An Escalent executive describes the problem and some steps plan sponsors might take:

“Creating a retirement plan that is attractive to employees is even more difficult in the current volatile economic and talent environment,” said Sonia Davis, senior product director at Escalent. “In order to combat participant fears, our research supports that plan sponsors need to encourage employees to keep a long game strategy, avoid drastic withdrawals that will hinder future retirement readiness and think beyond saving by seeking help with their decumulation phase.”[6]

Though we’re not precisely certain, we imagine that “thinking beyond saving by seeking help with the decumulation phase” means “retired participants can’t spend money that’s not there so they must learn how not to spend or how to spend less than they planned or hoped for in their golden years.”

Educating Recipients

Many participants in 401k’s and pension plans have never experienced a downturn like the one currently hitting investors. One observer stresses the importance of education:

“Employee education that emphasizes the importance of long-term investment strategy and dollar cost averaging is more crucial as many new employees in the workforce have never experienced a prolonged market downturn,” said Rikin Patel of Kingswood U.S. Enterprise.[7]

Younger plan participants can view downturns as terrific buying opportunities and with dollar cost averaging can obtain lower average costs of certain investments. But older participants surely view a severe downturn as a direct threat to their security, and, as a result, must adopt more defensive strategies to preserve capital.

Please Call Us

If you have any questions, comments, or suggestions, please call us at 301-294-7500. We are always happy to answer any questions you have. 

[1] https://www.investopedia.com/ask/answers/042415/what-average-annual-return-sp-500.asp
[2] https://www.slickcharts.com/sp500/returns/ytd
[3] https://escalent.co/news/retirement-plan-sponsors-indicate-concern-of-underperformance-in-volatile-market/
[4] https://escalent.co/news/retirement-plan-sponsors-indicate-concern-of-underperformance-in-volatile-market/
[5] https://escalent.co/news/retirement-plan-sponsors-indicate-concern-of-underperformance-in-volatile-market/
[6] https://escalent.co/news/retirement-plan-sponsors-indicate-concern-of-underperformance-in-volatile-market/
[7] https://www.investmentnews.com/pessimism-permeating-ranks-plan-sponsors-says-retirement-study-224798

 

EVs―The Next Big Thing

Special Message

by | Aug 1, 2022 | Learning, Most Popular

Look!

Have You Noticed?

Listen to any politician or any news commentator these days, and they always begin a discussion or answer a question like this:

Look, when I served in the Senate ….

Look, as I wrote in my last column ….

Look, if the Republicans won’t ….

Look, if the Democrats won’t ….

Just listen to the evening news tonight, and you’ll see what I mean. They all say “Look!”

Drives me a bit nuts.

But Maybe …

But maybe we should “look.” Look around us. Look at some statistics. Look at some developing trends. And when we do look, what do we see?

Economic Destruction

It’s not a pretty sight. Inflation drives millions to seek second jobs. Rapidly increasing mortgage rates are destroying the housing market. Applications for refinancing (to pay for higher prices of everything) have plummeted. Big retail outlets must rid themselves of bloated inventories, at a huge cost to their bottom lines. Truncated summer vacations might lower household expenditures for gasoline, but they also help shrink economic activity and add to recession fears. And if that’s not enough, a six-van tour service in Hawaii now needs only one of those vans―pain in paradise. It’s not a pretty sight.

How Bad Is It?

Seeking Second Jobs

Look at employment trends. If you’ve gone to any restaurant or driven up to a McDonald’s, surely you’ve seen the plethora of Help Wanted signs. And if you’ve gone into some of those restaurants, you often see lines waiting for a table but a bunch of empty tables inside. The owners can’t get enough wait staff or cooks to serve a capacity crowd.

Where did everybody go? Many sat out Covid and cashed Covid checks supplemented with unemployment insurance. They liked living at home or in their parents’ basements and just didn’t return to the workforce.

That’s about to change. In the words of Columbia Business School professor Mark Cohen:

At the end of the day, there are only so many credit cards you can load up and things you can avoid spending on before you come to the reality that maybe you have to pick up a second job. It’s about how much do you bring in every month, how much do you spend—if you’re in a deficit position, you have to find another job or an additional job.[i]

The inflation that used to be “transitory” has now transmogrified into an inflation that is “rampant.” Just two years ago, inflation hovered around 2.0%. Now in June 2022, it’s jumped above 9%. Not a pretty sight:[ii]

These elevated inflation rates are driving millions of Americans to seek a second job. Many of these second jobs are “full-time jobs,” which the Bureau of Labor Statistics (BLS) defines as a job requiring at least 35 hours per week. Thousands of our fellow citizens are forced to work two full-time jobs, or 70 hours each week:

426,000 Americans worked that much in June, compared to 308,000 in February 2020, according to the St. Louis Federal Reserve Bank’s analysis of BLS data.[i]

The numbers grow exponentially when we look at the number of Americans seeking second part-time jobs.

A new survey from Bankrate.com shows that, because of inflation, 41% of Americans say they need to pick up a second job in order to make ends meet. That’s up from 31% in 2019.[ii]

What? Forty-one percent of Americans. How many tens of millions of people is that? Not a pretty sight.

Housing Market

Look at what’s happening in the housing market―often a barometer of the economy at large. What was a boom for home-sellers has become an exercise in price-slashing:

The pandemic housing boom is careening to a halt as the fastest-rising mortgage rates in at least half a century upend affordability for homebuyers, catching many sellers wrong-footed with prices that are too high. It’s an astonishing turnaround. Just a few months ago, house hunters felt pushed to make offers within days, waive inspections and bid way above asking. Now they can sleep on it and maybe even shop for a better deal.[iii] 

The post-pandemic high home prices of just a few months ago are now driving buyers away. So sellers must dramatically reduce their prices:

The turn in the US housing market has been sharp and swift. Just ask Karlyn and Jack Stenhjem, would-be downsizers who dropped the asking price for their home near Seattle by almost $100,000 since May.

[Their] house, with private access to lakes and trails, is now available for $899,000, a price that makes Karlyn Stenhjem “cringe.”[iv]

ReFi Market―Up 4%?

Look at the refinance market. When inflation eats into disposable income, people seek other sources of cash. Many were tapping into their home equity by refinancing their mortgages at progressively lower rates. Not now. Those mortgage rates are going through the roof (so to speak). But a week or so ago, we saw refinance demand increase by 4%. But guess what ….:

Refinance demand rose 4% for the week but was 76% lower than the same week one year ago.[v]

No, down 76%. So another source of extra cash bites the dust:

Total mortgage application volume was 52.7% lower last week than the same week one year ago, according to the Mortgage Bankers Association’s seasonally adjusted index. Sharply rising interest rates are decimating refinance volume, and those rates, along with sky-high home prices and a shortage of houses for sale, are hitting demand from potential buyers.[vi] 

Unloading Retail Inventories

Look at what the biggies are doing. Target, WalMart, and other retail giants had it all figured out: When the pandemic ended, there would be huge pent-up demand. The shut-in consumers would spread their wings and open their purses and wallets. The payday would be huge

Oops. The heavy hand of inflation said no to those plans. Consumers certainly felt the new-found freedom of escaping the harsh Covid lockdowns, but inflation prevented them from buying high-end retail items and expensive clothing. Instead, they spent their money on gasoline, food, and other necessities.

The retailers faced a gigantic dilemma: What to do with bloated inventories? Put them on-sale? Offer a BOGO (Buy One Get One Free)? Store the goods for better times ahead? Offload them to bargain sellers like TJ Maxx?

Reuters wrote an interesting article about this quagmire: Sell, Stow or Dump? Retailers Wrestle with Mountain of Unsold Stock:

In the United States, clothing sales fell 89% in April from the same month in 2019, while in Britain clothing sales sank by 50% compared with an already-squeezed March.[vii]

So the anticipated post-Covid demand just isn’t there. If the big retailers opt to off-load expensive brands, savvy consumers should stand ready to cop some fabulous deals. Look at the plans of one California socialite:

“We’re going to see the most insane sales,” said Melissa McAvoy, founder of events company Luxury Experience & Co, who lives in the celebrity-studded Los Angeles suburb of Calabasas.

The 43-year-old said she planned to snap up merchandise at a discount, to then resell it at a higher price online at a site such as California-based Poshmark, which also makes money by taking a commission on sales.

“I’m going to get a tonne of stuff and either wear it once or put it on Poshmark,” she said.[viii]

Truncated Vacations

Look, or in this case, listen to identical conversations―typically between a Mom or Dad and their teenaged children―echoing throughout households across the country:

Mom or Dad: “But we are going to the beach this summer …. Just not quite as long.”

Teenaged Son or Daughter: “Quite? Last year we went for three weeks. And this year just one? That’s not fair.”

In millions of household budgets, money ordinarily set aside for vacations has jumped over into the column named “Gasoline” or “Weekly Food Budget.” Stats bear this out:

Majorities say they are likely to take fewer leisure trips (57%) and shorter trips (54%) due to current gas prices, while 44% are likely to postpone trips, and 33% are likely to cancel with no plans to reschedule. 82% say gas prices will have at least some impact on their travel destinations.[ix]

Needless to say, fewer people on the road affects the local economies of countless communities.

One short story from paradise makes the point:

Sunsets, surf and sand are still draws for visitors to Hawaii, but new statistics show their numbers are lower than usual for this time of year. That’s a big concern for those in the tourism industry, such as Carey Johnson, who runs Custom Island Tours. “We have four tour vans, I have six drivers,” she said. “So we can possibly be doing four tours a day, but right now we’re averaging less than one tour a day.”[x]

Look! Look Around You

You don’t have to look far to realize that this country―indeed, the entire globe―faces some dire economic circumstances. After the first quarter’s 1.6 percent decline in GDP and the second quarter’s 0.9 percent decline,[xi] the country officially entered a recession, according to traditional economic theory (two consecutive quarters of negative economic growth).

The White House begs to differ:

What is a recession? While some maintain that two consecutive quarters of falling real GDP constitute a recession, that is neither the official definition nor the way economists evaluate the state of the business cycle. Instead, both official determinations of recessions and economists’ assessment of economic activity are based on a holistic look at the data—including the labor market, consumer and business spending, industrial production, and incomes. Based on these data, it is unlikely that the decline in GDP in the first quarter of this year—even if followed by another GDP decline in the second quarter—indicates a recession.[xii]

Look, whether a recession begins with two consecutive quarters of negative growth or some other definition prevails, our citizens know that today’s economy isn’t doing the heavy lifting needed to sustain the livelihoods of  332,403,650 Americans alive on January 1 of this year.[xiii]

Will we come out of this mess? Yes, Americans always do. When? No one knows. But we can all look around us and see that things probably won’t get better before they get a whole lot worse.

But better they will get.

One day.

Call US

As always, please call us at 301-294-7500. We are happy to answer any questions you have.

EVs―The Next Big Thing

Special Message

by | Jun 8, 2022 | Learning

Bonds CAN’T Fall Any Lower… Or Can They?

What once was considered a “safe” investment has taken a drubbing in 2022.  As of yesterday (June 06, 2022) the AGG (US Aggregate Bond Index) has fallen 10.42% 1.  Just for the record, a 10% drop is recognized as an official “correction” for equities. It would be hard to disagree that a 10% loss in bonds can be viewed as a catastrophe in a conservative investment portfolio.

Today, the Federal Reserve Prime Interest Rate (aka Prime Rate) is 4% 2.  That doesn’t sound that bad.  Especially compared to the past 40 years.  On December 19, 1980 the prime rate was a remarkable 21.5% 2.  It has fallen over the past 41 years to as low as 3.25% 2.  Comparatively, 4% vs 3.25% is barely a blemish on the safe and smiling face of the bond market…or is it?

Consider that interest rates historically move in the opposite direction of bond values.  As interest rates fell over the past 41 years, bond values have steadily been rising.  After 40+ years, bond investments have always been represented as the safe and conservative investment position.  After all, it’s difficult to  even remember when the last time it was this bad.  It’s been since 1977 that bonds values have fallen this painfully when surging inflation and spiking gasoline prices were hurting consumers. Sound recently familiar?

​The Federal Reserve (FED) is attempting to quell inflation with interest rate hikes.  The FED has indicated they will continue to raise rates by .5%  until inflation calms down and then they plan to raise future rate by .25% increases until they get inflation fully under control.

Until the FED navigates us out of inflation, you can expect bond values to continue to fall.

In our opinion, the day of fleeing to bonds for safety is gone, at least for the near to mid-term. 

So, the likely question on everyone’s mind is, “How does one avoid more and more losses in bond investments?”

Active management is our answer. 

As mentioned above, the AGG has fallen 10.42% 1.  We are active managers, and our Model Fixed Income account has lost only 2.51% in 2022 through June 06, 2022.  That is nearly an eight-percentage point difference between the benchmark and our returns.  It’s a lot easier to recover from a negative 2.5%  than from a 10% loss.

Essentially, you have three options:

1.       HOLD your bond investments and hope that interest rates fall in the very near future
2.       SELL your bond investments, go to cash, and endure the loss of purchasing power to the high rate of inflation
3.       ACTIVELY MANAGE your bond investments to avoid further losses and capture their eventual upswing

We believe Active Management is a path that gives you the best chance for success.

If you have questions or just want to talk about your concerns, please don’t hesitate to contact us.

 

 

Sources:

1.        https://www.investing.com/etfs/ishares-barclays-agg-historical-data (reset the date timeframe to 1/1/2022 through 06/06/2022 and look at the cumulative total loss of the AGG at the bottom of the data listing)
2.        http://www.fedprimerate.com/wall_street_journal_prime_rate_history.htm#current (all dates are listed)

 

EVs―The Next Big Thing

Important Market Update

by | May 3, 2022 | Learning

Dear friends and clients,

You’ve heard about it on the news, you’ve felt it at the grocery store and at the gas pump, you’re having to deal with it every day. 

It is inflation.

We didn’t hear much about it in the news or feel its impact until very recently.  With a 1.4% increase just in the month of March, the US Producer Price Index (PPI) recorded the highest ever year-over-year increase in history. The famous US Consumer Price Index (CPI) saw its highest year-over-year increase in 40 years. Together, these two price indexes highlight the serious threat rising prices have on your purchasing power and your investment portfolios.  In other words, inflation does not limit its impact to your grocery purchases, it is also weighing on your life savings, and for many, their daily choices.

Inflation’s impact on the financial markets has been strong and immediate.

Familiar stock market Indexes

·         S&P 500 Index (SPX)  -13.31% (NEGATIVE)

·         NASDAQ Composite Index (COMPQX)  -21.16% (NEGATIVE)

·         Dow Jones Industrial (DJ-30) Index  -9.25% (NEGATIVE)

·         Barclays Aggregate Bond Index (AGG)  -9.83 (NEGATIVE)

Yes, you read that correctly.  All major indexes are languishing in negative territory.

·         S&P 500 is in correction territory (10% loss)

·         Tech-heavy NASDAQ is in bear market territory (20% loss)

·         Dow Jones is just ¾ of 1% shy of being technically designated as being in correction

Add to that the beating taken by bonds this year.  If you have traditional bonds or bond funds, you’ve likely seen your bonds values fall and accordingly the AGG is just 17 basis points shy of being in an official correction.  For bonds, that is serious because many have been led to believe they are a “safe haven” for retirees desiring a less risky investment. 

If you recall our presentation from September 2020 entitled “Dangerous Times”, you’ll remember we illustrated and warned of a perfect storm forming due to 40 years of falling/low interest rates and low inflation that led to all-time low interest rates and all-time high stock market values.  The perfect storm is now on our shores.  Rising interest rates and inflation are sending markets tumbling and bond values crashing.

In this storm, it seems like there is no good place to hide and wait it out.  Historically, when inflation grips our economy, cash loses purchasing power and commodity prices rise as a hedge against falling market indexes.

What is a commodity? 
A commodity is a basic good used in commerce that is interchangeable with other like-commodities. Traditional examples of commodities include grains, gold, beef, oil, and natural gas. The basket of commodities is varied and wide ranging; so, not all commodities will be a worthwhile inflation fighter.

Here are a few Exchange Traded Funds (ETFs) that represent various commodities and their results.  The percent return is for 2022 year-to-date through 4/29/2022.

Agriculture / Food

·         WEAT (Wheat) ETF 41.00%

·         CORN (Corn) ETF 39.18%

·         SOYB (Soybeans) ETF 25.63%

·         TAGS (Agriculture) ETF 27.69%

·         CANE (Sugar Cane) ETF 4.13%

·         JO (Coffee) ETF  -1.65% (NEGATIVE)

Energy / Oil / Alternatives

·         UNG (US Natural Gas) ETF 100.16%

·         USO (US Oil Fund) ETF 41.94%

·         XOP (Oil & Gas Exploration & Production) ETF 37.49%

·         TAN (Solar) ETF  -16.55% (NEGATIVE)

Natural Resources / Metals / Mining

·         JJN (Nickel) ETF 52.54%

·         SLX (Steel) ETF 17.07%

·         GLD (Gold) ETF 3.48%

·         URA (Uranium) ETF 1.62%

·         WOOD (Timber/Forestry) ETF  -2.07 (NEGATIVE)

·         SLV (Silver) ETF  -2.19 (NEGATIVE)

·         LIT (Lithium) ETF  -22.8% (NEGATIVE)

While many commodities can be good inflation fighters, they can also be volatile.  As a result, you may have seen or will see RFS purchase an ETF and sell it rather quickly.  Our buying and selling rules are in place to prevent catastrophic losses while attempting to capture as much upside as possible.  This requires trends and indicators take root…which usually means we need to allow the ETF to solidify its direction over several days.  Once the direction seems solid, we act accordingly.

Nearly all of the above commodity ETFs are constrained by low daily volume and/or tax reporting complications.  As a result, Research Financial Strategies is limited to investing in diversified commodity ETFs such as energy and agriculture.

·         IXC (Global Energy) ETF 28.97% YTD

       o   Purchased 2/3/2022 is up 8.27%

·         PDBC (Commodity ETF 32.65% YTD

       o   First lot purchased on 3/22/2022 is up 4.19%

       o   Second lot purchased on 4/27/2022 is up 0.17%

These returns may sound small; however, when you compare them to what is happening to the markets overall, then you’ll find they are going in the opposite direction which is the right direction.

Do you have bonds? 
If so, then you may have noticed we sold many ETFs and mutual funds a while ago and purchased TBT.  TBT is an ETF that benefits from the 20-year treasury decreasing in value.  As mentioned above, rising interest rates negatively impacts bond values.  With the expectation that the Federal Reserve will continue to raise rates several times over the remainder of this year, it looks like bond values will continue to fall.  As bad as that sounds, your bond portfolio will benefit.  Since TBT was placed in our bond model portfolio it has earned 9.04% through 4/29/2022.

You may have noticed our equity and bond models both have large cash positions.  This is done on purpose.  Cash is a good loss-avoiding hiding place and better than bonds currently.  Inflation may erode some of your purchasing power while in cash but at least it won’t be exacerbated by bond losses.

How are we fairing?
2022-YTD as of 04/29/2022: 

·         RFS Bond Model  -1.35% (NEGATIVE) vs AGG Index  -9.83% (NEGATIVE)

·         RFS Equity Model  -13.56% (NEGATIVE) vs S&P 500  -13.31 NEGATIVE)

·         RFS Equity Model  -13.56% (NEGATIVE) vs NASDAQ  -21.16% (NEGATIVE)

RFS is beating the AGG and NASDAQ handsomely and keeping pace with the S&P 500.  Going forward we imagine a favorable rest of the year.

Bottom line, you, as an RFS client, are poised to potentially benefit as bond values fall and commodity prices rise.  No matter how long this turmoil lasts, we’ll be there fighting for you.

Questions? Please call us. 301-294-7500

 

 

Sources:
ETF and Index returns calculated using TC2000
Spotlight: Come On, Commodities by Direxion Funds
Commodities on Investopedia.com 
https://www.investopedia.com/terms/c/commodity.asp

 

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