More and more states are legalizing cannabis and its by-products for medicinal and even recreational use.  As its legal use grows, companies will get involved in all aspects of cannabis – cultivation, formulation, distribution, sales, and marketing.  Cannabis companies may start to look like other companies.  Some are already publicly traded.  Does that mean there are investment opportunities for the individual investor?  Possibly, but there are a lot of issues to overcome before cannabis can enter the realm of institutional-quality so that it can attract large chunks of money.

It Is Still Illegal at the Federal Level

The biggest problem for cannabis is that it is still illegal at the Federal level.  The Feds have made noises but have as of yet not made efforts to negate individual state laws that have legalized cannabis at some level in their states.  My guess is that it will still be a while before the Feds legalize it – I doubt the Feds will go the other way and crack down on the states.  

A number of problems fall from the fact that cannabis is still illegal:

• Just on the surface, it would be bad optics for an institutional-level investor such as a pension fund to invest in a company whose product is illegal, even if it is “legal” in some states.  
• Companies involved in cannabis currently have and will continue to have a difficult time gaining banking relationships.  This goes all the way to even having a deposit account at a large national bank.  Is there much difference between a company that sells cannabis and the street corner marijuana dealer, in terms of what they can do with their sales revenues?  Not much, if you look at it at the macro level.  Even larger cannabis companies still can’t get standard banking relationships.  They have to do business the old fashioned way – in cash.  Meaning, these companies have to hoard stockpiles of cash.  Not exactly a modern or efficient payments system.

Drug Approval

Another problem that prohibits institutional investment follows from the drug approval process.  One reason for the growing use of cannabis is its reported medicinal qualities.  My thought is, if some cannabis producers tout its ability to alleviate depression or what have you, why don’t they just go through the FDA process and get cannabis approved as a drug by the FDA, just like any other pharmaceutical company must do to get its drug approved?  Well, the problems are 1) cannabis is illegal (see above); and 2) companies can’t patent it.  With other new drugs that get approved by the FDA and come onto the market, the pharmaceutical company that developed the drug has patented the chemical mixture that comprises the drug.  That can’t happen with cannabis because its use is already widespread – the cat is already out of the bag.  Now there are companies that are trying to use the FDA process but they are small-scale thus far.  Again, until the Feds give cannabis some legal status, the FDA is not likely to get involved, and cannabis will not grow to be a drug class like any other standard drug class.  As a result, it will continue to be shunned by institutional investors.

IMO

If you find a flyer opportunity at the company level in the broader cannabis industry that you think could take off, by all means give it a shot, but keep in mind it will be an uphill battle for the foreseeable future because institutions including banks won’t touch it.  Don’t bet the farm on cannabis.

I read an article on another website that touted a stock because it payed a dividend of in excess of 6%.  Sounded intriguing to me, so then I checked its chart and found that the stock is down about 14% YTD in 2018.  Rising interest rates are usually bad for dividend stocks.  You get the 6% dividend but the value of the stock has gone down 14%, so despite the dividend you are down 8% for the year.  Granted, the stock in question could have gone up as easily as it could have gone down.  But, even with the dividend, you are at risk for losing principal value.

Dividend Companies

In my opinion, if you invest in a company that pays a relatively large dividend, plan on the dividend comprising the bulk of your return on that investment.  Your stock may prove to be a hedge against inflation, particularly if it is a real asset-heavy company such as a real estate company or oil and gas.  However, don’t invest in a dividend play if you are looking for substantial growth in your capital.  The reason for this is intrinsic:  Companies that pay dividends are typically more mature companies that have already gone through their growth phase.  Think about it:  A company makes money by selling a product or service.  It can do two things with the leftover money after it pays its workers:  1) It can retain its earnings and plow it back into the company in the form of research and development or acquisition of new assets, or 2) It can pay it out to its existing shareholders in the form of dividends.  Companies that choose the #2 option of dividends typically already have enough money to fund their growth, and have calculated that any additional investment back into the business that they currently see would not be “accretive”, meaning its marginal return would not be equal to or greater than the return they already make on existing business.  Therefore, these companies conclude it is best to let the shareholders do what they want to with the money that they earned, perhaps by investing it in other companies.  Other companies, such as Real Estate Investment Trusts (REITs), pay high dividends because the tax code incents them to do so:  REITs don’t pay taxes on income that they pass through to investors.  

Mature Companies = Mature Investors

Investors who are seeking dividend returns are typically more mature (in age) investors, at or near retirement, who are seeking to bolster their income.  If you think about it, that fits the profile of the companies that pay the dividends:  Mature companies that want to live off of the fruits of their labor.  We’re older and ok with where we are in life right now, just with a little more income.

Safety of Principal

The trick, if you are a dividend investor, is to try to retain as much capital as you can so that if you have to sell it you get your money back.  That is why dividend investors should invest across a number of companies and a number of asset classes.  For instance, large oil companies typically pay dividends.  However, if the price of oil goes down, the stock goes down (and the yield probably goes up unless the company cuts its dividend, which typically doesn’t happen).  So, you don’t want to be overweighted in the oil business.  Think also about other companies and other sectors that pay dividends, such as the aforementioned REITs as well as utilities and many other large industrial companies.  Even Microsoft pays a dividend (1.5% – one could argue it should be more with their current cash hoard).  

IMO

Look at dividend investing as the dividend plus a potential hedge against inflation.  Look at dividend stocks as an alternative to bonds, but with more risk.  If you diversify your holdings, you may minimize company- or industry-specific risk and you may be able to achieve your goal of a healthy cash flow through the dividends plus a principal balance that may at least keep you even with inflation.

You may think that only people who live in vulnerable areas on the East or Gulf Coast are subject to hurricane risk.  However, what if the hurricane moves 200 miles inland and drops 10 inches of rain that causes rivers to flood?  Will standard Homeowners Insurance cover damage from a hurricane 200 miles inland?  Probably not.

Homeowner’s Insurance

Most home owners have standard Homeowner’s Insurance.  The standard rule is:  If the damage occurs due to something falling from above, you are covered, but if the damage occurs due to something rising up from below (such as water or flooding), you are not covered.  “Yes, but it was the rain from above that caused the flooding from below to happen.  Doesn’t that mean I’m covered?”  The insurance company doesn’t view it that way, and they have a lot of legal precedent on their side.  You will not be covered if a hurricane (or any big storm) hits and the resulting storm surge or flood infiltrates and damages or destroys your house.  Sorry!

Flood Insurance

The best way to be insured against floodwaters is avoidance:  Don’t live near a body of water or in a flood-prone area.  Live on high ground.  However, if you are already there, you should think about buying a separate Flood Insurance policy.  Some mortgage lenders require it if you live in a FEMA Flood Zone.  The dominant Flood Insurance provider is the National Flood Insurance Program, backed by the US Government.  Their insurance has caps on coverage, has high deductibles, and is expensive.  In other words, it’s not very good, in my opinion.  However, it is the only game in town for much of the US.  There is private insurance available in some states and some areas, so you might want to check those out, but don’t get your hopes up.  Flood insurance is hard to get.  Like I said, don’t live in a low-lying area.

Windstorm Insurance

If you live in a hurricane- or tornado-prone area, your Homeowner’s Insurance may not pay for damage directly caused by the wind, such as the wind directly blows the shingles off of your roof.  You may need a separate Windstorm Insurance policy to cover direct wind damage.  There is no Federal Windstorm Insurance, so you have to work with private insurers.  I don’t have experience with this type of insurance, but Google it and a number of insurers will pop up.  I would expect low levels of coverage and high deductibles.

IMO

If you live in a coastal East or Gulf Coast area and you want to be For Sure For Sure For Sure, then you want to have Homeowner’s, Flood, and Windstorm Insurance policies.  All three.  Very expensive, and possibly difficult to find and with high deductibles and low caps on coverage.  Hope it is all worth it to you.  People who are not adequately insured may try to look to the Federal or State government for help.  This is politically controversial.  The media shows images of flooded homes and then interviews the owners afterward inspecting their flood-damaged homes, and so it becomes politically difficult to deny helping these people.  Then, if you think about it, many homes that are directly on the beach front are very expensive.  You have to pay up for that beautiful ocean view.  Some of these may not even be primary residences for the owners.  If these wealthy beach front home owners are flooded out and are not adequately insured, how does it look politically to bail them out?  Probably not good for them specifically, but they get lumped in with the poor people inland who are flooded, and so they get the benefit.  That’s why we get into the $Billions of damage for some of these big storms.  Avoidance is your best insurance, if you are able to avoid these hurricane- and flood-prone areas.

Investing in emerging markets sounds like a great idea but it is difficult to do successfully if your native currency is the US Dollar.  It is difficult for a number of reasons, including the following:

• Some emerging market currencies are not easily convertible to US Dollars at a reasonable exchange rate.  
• Some countries do not allow direct investment in their businesses by Americans or any foreigners.
• Tariffs can really hurt emerging market economies, both because of the added cost of the tariff and because of the political uncertainty associated with them.
• The exchange rate will continue to be a problem even after you have invested your money.  Right now, for instance, the US Dollar had been killing emerging market currencies.  Emerging markets have been significantly hurt by extreme devaluations particularly of the Argentine Peso and the Turkish Lira.  
• Interest rates:  The US has been raising interest rates while most of the emerging market world has not.  The result of this differential in rates is that the US Dollar goes up and emerging market currencies go down.  So, even if an emerging market company is performing well in its native currency, Americans investing dollars in that company may be losing money because of the currency effect, which is largely driven by differences in the direction of interest rates in the respective countries.
• Want to buy a mutual fund that specializes in emerging markets?  That is a possibility, but do your research before you buy.  Many emerging market mutual funds charge high expenses – reasonably so due to the travel and other expenses commensurate with managing investments in emerging markets all over the globe.  Go to Morningstar.com and research the holdings of the fund that you are interested in.  Many of these funds’ top holdings are banks and financial services companies domiciled in emerging markets.  You think about Emerging Markets and you think about cheap labor for manufacturing and you think this is where all the money is being made.  However, many emerging market industrial companies are not publicly traded.  As a result, the fund managers revert to owning financial service companies, which is a derivative play with respect to where the growth in these emerging markets is.  My point is, you may not be getting a true emerging market investment experience when you invest in emerging market mutual funds.
• This includes ETF’s.  The largest emerging market ETF is the EEM, which tracks the iShares MSCI Emerging Markets Index.  Its two largest holdings are Tencent (China) and Taiwan Semiconductor, both of which are huge companies.  Country-specific ETF’s, of which there are many and probably one for any country you can think of, are also weighted toward the largest public companies in each country.  Nothing wrong with any of that, but you are investing in large companies, including many banks, when you invest in ETF’s such as the EEM or country-specific ETF’s.  
• There are alternative investments such as hedge funds and private equity that specialize in emerging markets, but you really have to know what you are getting into, and you will likely pay high fees and be unable to cash out when you might want to.  

IMO

I view Emerging Market investing as a component of a well-rounded portfolio.  It makes sense that, while the US is the world’s largest economy, it is not the majority of the world’s economy, and that there are probably some great growth opportunities in emerging markets.  With the way emerging market investing is currently constituted, you can capture some great growth opportunities through investing in mutual funds and ETF’s, but it is difficult to find a pure play in emerging markets.  Another way to view emerging market investing is as a hedge against a weakening US Dollar, if current trends reverse and the Dollar starts to weaken.  

My wife and I recently cleaned out our cupboard. We had bought some new cups and glasses and the cupboard was now too full. It had been several years since we had cleaned up the cupboard and we had accumulated a lot of items that we found that we weren’t using. Our children are either working (and off the household payroll!) or away at college (and still very much on the payroll). So, a couple of weeks ago, it was out with the old and in with the new! Most of the “treasures” that we either tossed or donated probably won’t be missed – we didn’t talk with our kids about this. Now the cupboard is much less crowded and much easier to deal with. Now it is a joy to open it up and see all of our glasses and cups properly arranged and easily accessible!

The Moral 

The moral of the story:  Clean out your own cupboard, in the greatest meaning of the phrase.  As we get older (and we all do), things we accumulated over time may not have the same application or use now that it did when you bought it.  When you get to a certain age, you want to move forward with less, not more.  It’s easier to maneuver that way and things are more orderly.

Rebalance

This goes for investments as well as for personal possessions.  A stock you bought several years ago may have already run its course.  Maybe you are hanging on to that stock because you haven’t gotten around to selling it, or you think it still has room to run.  Instead, maybe you should sell it now and redeploy the money into something you think can grow at a higher rate, or don’t redeploy it and keep it as a cash gift to yourself.  One way to “clean out the cupboard” in your investments is to rebalance your portfolio at least once per year.  Set a goal of what your asset allocation should look like – say 60% stocks and 40% bonds – and make sure it looks like that every January 2, or any other date of your choosing.  

IMO

Just like some people need a personal trainer to motivate them to get to the gym and do their exercises, you may need a Financial Planner to keep you in financial shape.  The Financial Planner will encourage you to clean out your cupboard (financially), not necessarily because they are paid by the transaction, but because it is in their best interest to do so.  Please contact me if you want help cleaning out your own cupboard!

 

How much do you think you will spend once you retire?  Most likely, you believe your spending will go down once you retire.  A Rule of Thumb is your spending during retirement will be 70% of what it is when you are working.  

Does the 70% Rule of Thumb work in practice?  This article from a recent edition of the Wall Street Journal suggests that not only is 70% of pre-retirement spending too low of an estimate but that your retirement spending may actually be more than you spend while you are still working.  Once you retire, you will have a lot more free time to do things, many of which cost money.  It costs a lot just to run a home!  I spend almost $100/month just for internet access.   You have to have internet access these days, right?  Add cable or satellite TV to that.  Did you “cut the cord”?  Not really, if you are still paying for internet access.  Especially if you are still working and already on a tight budget, I can understand how your spending can increase instead of decrease during retirement.

Chart

What I find particularly useful about the WSJ article is the chart it has in it, which is shown above.  The chart is really a checklist of categories to consider when you think about what you spend your money on.  The bulk of the article discusses each item in the chart and explains what each means.  I suggest using the chart as a starting point for you to do an inventory of what you are currently spending money on.  Then, look at each spending item and think about whether it “sparks joy” for you.  Or, if it doesn’t spark joy, maybe it is necessary – insurance doesn’t spark joy, but you have to have it.  If you are thinking about retirement in the next several years, use this chart to create an action plan of what you want to cut out.  Because, if you don’t cut anything out, your spending could easily go up during retirement instead of down, and you may not have enough money, especially if you remain in good health and live a long time in retirement.

IMO

While you are working, you should always have an action plan for what you plan to jettison if something bad happens, such as loss of a job, huge medical bill, or loss of a spouse or a loved one.  When you do actually pull the trigger and retire, use this chart as well as your current expenditures as a path toward knowing how you are going to afford your retirement.  Do you know any older people who worry a lot?  Don’t be a worrier in retirement – put your retirement spending plan together and execute it.  You will be happier in retirement if you do.  Need help?  Contact me!

My son who is taking an Economics class in college asked me, “What is the greatest Macroeconomic risk we currently face?”  I responded that it was Monetary Policy – he needed only a general area of risk.  What I really think is that the greatest Macroeconomic risk is how the economy responds as the Federal Reserve reverses course and sheds assets over the next few years, as it has said it would do and as it has, in fact, started to do during the past few months.  I didn’t lie to my kid – this is a part of Monetary Policy.  I believe the Fed’s actions with respect to its own balance sheet is the greatest current Macroeconomic risk because it hasn’t been done before and because another economics-related branch of government, the Congressional Budget Office, doesn’t even list the Fed’s asset sales as a risk in its most recent economic forecast.  It is often the part of the iceberg that you don’t see that poses the greatest risk.

$4.4 Trillion

The Fed’s assets peaked in 2014 at about $4.4 Trillion.  The Fed’s assets on their balance sheet consist of debt instruments (Treasury securities, mortgages, and other government-backed debt).  The Fed started aggressively to purchase debt in the open market as the Great Recession hit in 2008-2009.  The Fed’s purchase of debt provided liquidity to the markets and helped the economy to recover from the Recession.  They continued to buy so much debt that their balance sheet grew from about $1 Trillion when they started to $4.4 Trillion.  I previously wrote about this in my post of March 30, 2018, titled “No Playbook“.  Football coaches operate with a strict playbook.  The Fed is currently operating without one that they have tested during practice.

Now the Fed is starting to go the other way:  Selling assets instead of buying them.  In reality, the Fed is simply not repurchasing assets as they mature and fall off of their balance sheet.  After holding steady in the $4.4-$4.3 Trillion range since 2014, the Fed’s assets have shrunk this year by about $200 Billion, and are now at about $4.2 Trillion.  The Fed is hoping that this gradual sell-off of assets will not disrupt the economy that much.  They are taking the training wheels off gradually.  Let’s hope that they are correct.  The economy is strong now by most measures.  If the economy unexpectedly begins to weaken, the Fed might be forced to curtail or even reverse its bond selling program, which would not be good for the Fed’s credibility.  

The CBO

The Congressional Budget Office (CBO) puts out a periodic Macroeconomic projection.  The most recent projection was published on August 13.  The projection mentions various issues they see that may have a negative impact on the US economy.  Trade issues, tax cuts, and interest rates are mentioned.  The mainstream media mentions these as well.  Fed policy relating to asset sales and shrinking its balance sheet is not mentioned as a risk in the CBO projection.  That makes me worry.  For the past 10+ years, our economy has been helped along by the Fed’s ballooning balance sheet.  That balloon will be having air let out of it – gradually, but still with less inflation.  I certainly see this as a Macroeconomic risk.  The CBO misses this risk.

IMO

I do not see our economy going into a recession because the Fed has started and will continue to reverse course.  However, if the Fed needs to re-reverse, there could be hell to pay.  My point is to pay attention to the Fed’s actions (I will keep you posted) and see what happens but be aware of what is happening.  

Last week, the week of August 20, marked the Longest Bull Market in history.  This means 3,453 days had elapsed since the start of the bull market in March 2009, which surpassed the previous record bull market that ended in March 2000.  Although this current bull market is a record in length, it is not a record for return percentage, as the 1990’s bull market (fueled by the dot-com boom) saw a 417% increase, vs. “only” 322% for this bull market.  Nevertheless, darn good returns.

What Does It Portend?

What does having just experienced the Longest Bull Market mean with regard to stock prices and investment returns going forward from here?  In a word, Nothing!  The fact that we have had a 10-year bull market doesn’t mean you shouldn’t go in and buy stocks tomorrow.  The two are not statistically correlated.  “Yes, but it can’t go on forever, can it?”  Probably not – forever is a long time – but it certainly can continue for a while longer.  The underpinnings for a strong stock market are still there: strong corporate earnings and relatively low interest and unemployment rates.

Sports Psychology

Any sports psychologist will tell you that the athlete’s sole focus during competition should be on the next thing – the next play, the next pitch, the next hole, the next serve.  Athletes are taught to have zero memory during competition, whether the athlete has been performing well or not.  Always look forward and never backward while competing.  The same should be true for investors.  Look forward, not backward.  Just because the market has been strong doesn’t mean that it won’t be strong in the future.  In fact, perhaps just the opposite.

IMO

When investing, keep your game face on.  Don’t fret over missed opportunities in the past.  Don’t think that you are better than you are because of a recent hot streak.  Instead, keep your goals in mind and go out and execute your plan.  Don’t be a Glass Half Empty person and think the markets are bound to correct because they have been going up for so long.  That type of mental predisposition is a recipe for failure.  As the British say, Keep Calm and Carry On.