The Sane Investor

July 31st, 2008

The big news of course today coming out of the markets is the recent report on United States GDP growth (GDP stands for Gross Domestic Product, and is the total of consumption plus investment plus government spending plus net exports in the United States. In the US, since we have a trade deficit [we import more goods than we export], the “net export” value is negative.) Bloomberg today reported that GDP grew at an annualized pace of only 1.9% last quarter, compared to what analysts had predicted of 2.3 (median prediction). This lower-than-expected rate has lead many economists to believe that the United States indeed is in a recession.

Many oil analysts have pointed to increasingly bearish economic indicators to suggest that demand has come to the forefront of crude oil concerns, and that with a recession practically imminent, American demand for gasoline and crude oil will continue to slump as Americans continue to drive and consume less.

Job Loss Data is More Mixed

This news on GDP growth comes off of yesterday´s report that jobs remained surprising resilient:

“The U.S. dollar strengthened yesterday [7/30/08] after ADP Employer Services reported that companies added 9,000 jobs in July after cutting a revised 77,000 positions in June. The report is a leading indicator of tomorrow’s Labor Department employment data. Non-farm payrolls fell 75,000 this month following a drop of 62,000 in June, according to economists surveyed by Bloomberg”.

As far as trying to determine whether or not demand for gasoline and petroleum products will continue to slump, employment levels are extremely important, since fewer Americans earning a salary means fewer Americans driving to work every day and less money being spent in the markets. Thus, erosion in employment levels would serve to further increase oil demand risks. The ADP´s surprising report of jobs actually being added provided a new bullish dimension to crude prices. This data, along with the reduction in gasoline inventories in the United States, helped to spark an upswing in oil futures contracts yesterday.

Gasoline Inventories Decline

The big news yesterday for crude was the gasoline inventories report, which showed a 3.58 million barrel decrease in inventory levels, compared to what was supposed to be a 0.35 million barrel increase. The summer months in the United States are seen to be the “driving months”, as people on vacation, visiting relatives, or just enjoying the warm weather spend more time driving around.

Although the inventories moved in the opposite direction than that which was predicted, “[t]he drop in gasoline inventories last week left stockpiles 3 percent higher than the five-year average for the period.” The level of inventories is important because it represents the stockpile, so to speak, that the United States keeps to lessen price volatility and to decrease the possibility of spot shortgages and supply shocks. Although this data suggests that we are at larger risk than we would have been towards supply shocks or if relations with Iran were to suddenly turn sour, it definitely decreases the risks that crude prices will continue to escalate in the near term.

Not Even All The Oil Companies Are Happy

Although many news sites are reporting that Exxon Mobil (NYSY: XOM) reported higher than ever earnings at $11.68 billion, the fact of the matter is that they still missed their earnings targets.

According to Bloomberg:

“Exxon slid $2.78, or 3.3 percent, to $81.60. Production tumbled 7.8 percent after assets were seized in Venezuela, Nigerian workers went on strike and record prices triggered contract clauses that give oil-rich governments a bigger share of output”.

With this news, investors have begun to lose their one alternative, which was to go with energy companies.

We Haven´t Found A Price Floor Yet

After yesterdays news, I was going to declare that we had just found a price floor in the $125 region, and that we would continue to bounce around in this region until some bigger news came around. However, today´s news that GDP growth may continue to lag, igniting recessionary concerns, could likely continue to push oil lower.

Although you may likely be reading pieces claiming that oil doesn´t have merit being above $100 a barrel (I talked about one in this piece), I´m going to go ahead and say that if oil falls below $120, I´d go long for it in some sort of ETF that tracks crude oil performance. My thinking is that if oil continutes to drop, unless we see some serious economic concerns, demand will rise for gasoline, eroding inventory supplies. If inventories continue to fall, I see significant risk of short term supply shocks and spot shortages.

In The Long Term, Look To Emerging Markets

The focus of all this crude oil discussion has always been on the United States, by far the largest consumer of oil per capita. The concern is that worldwide demand for crude will slump led by the United States. However, it doesn´t appear as though Asian markets will be able to repeal their energy price subsidies anytime soon, without extreme threats to instability. Because of this, although per capita consumption in the U.S. might fall, I definitely see overall worldwide demand for energy increasing over the longterm, with (cheap) supply continuing to fall. Because of this, I´m maintaining my long term bullish perspective on crude.

I would recommend in the short term however shorting or purchasing ultra short/short etfs in oil until it enters in to the $110 per barrel region, or until we see more promising news related to demand and economic stability comes out.

Disclosure: the author of this article is double-long crude

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So if you pick up a newspaper or turn on the TV, it is abundantly clear that not all is well in the realm of financials and commercial banking.  It would seem as though we’ve entered in to a vicious cycle, where defaulting debt leads to further losses and those losses then lead to further defaults.  Banks have had to increase their reserves, or the amount of liquid assets (i.e. cash) that they hold at any one point to prevent failures and collapse.  This is all really bad news, but there is something that you can do to help with it, and you’ll end up helping yourself in the process.

Empty Out That Bowl of Change

If your family is anything like mine, you likely have a bunch of loose change just hanging around the house, and maybe even a bowl where everyone throws their change that they’ve accumulated throughout the day after work.  It may not seem like a lot of money; potentially it’s your “rainy day” fund so to speak.  But what I’m advocating for is that you pick up that change, put it in a bag, and head on down to the bank when you deposit your next paycheck.

You’re Insane

I know, it sounds absolutely batty.  Can you imagine, everyone in line at the bank with deposit slip in hand and a ziploc bag full of money?  It sounds crazy, but just think of this: there are 300+ million people living in the United States right now.  If everyone brought in five dollars of the spare change they have lying around the house, that would amount to 1.5 billion dollars.  That’s a lot of cash that could go a long way towards helping banks out of financial trouble and helping out your fellow American.  Banks could be a little less tight on the lending, and soon good money from well thought out mortgages and loans could help overcome the bad money being lost to default.

It’d Help You a Little Bit, Too

The inflation rate in the United States is speculated to be rising at the moment, but it typically falls out to 3% a year.  That means if you have that jar sitting in the entryway, every year it loses 3% of its value.  So when you think about it, you’re not really saving that money: you’re just watching it lose value.  So why not take it to a bank, shove it in a savings account, and at least cancel out that inflation?  If you have a good enough savings account, then you’ll be earning a little bit of money on top of that!  Now that’s real savings.

It’s Not as Dorky As You Think

It’s the typical gag: you’re waiting in line at the bank, and none of the lines are moving.  You look over, and a grandma is watching the teller count out pennies as you stare at the clock and slowly watch your lunch hour drain away.  However, the times have changed.  Long gone is the manual counting at the teller window.  Nowadays, you bring in a bag of money, they dump it in to a machine, and it spits out the amount of  money you deposited.  I did it today at Wells Fargo.  I had only filled a large ziploc bag about an eighth of the way, and my friend and I were both exceptionally surprised at the result: $28.65.  Can you imagine that?

The Bottom Line

Now you may think I’m a complete loon, but I’m just telling you: even if you don’t think it will help the financial situation we’re in, do yourself a favor and take in that spare change!  Even if it’s three or four dollars, that’s money you’ll actually use rather than just watch get eaten away by inflation.  So stop letting those nickels and dimes be lazy: make them start working for you in a savings account!!

Questions? Comments? E-mail me at thesaneinvestor@yahoo.com

All material copyright

© 2008 Andrew Jarmon

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We’ve all been there before…we see news about pension funds and 401(k)s, and we either change the channel or go to the next page. It’s really easy to say: “I don’t need to worry about that yet, that’s for when I want to have kids and I’ve chosen a career!”. The fact of the matter is, most of us can’t imagine taking money we’re earning right now and saving it for something 40 years down the road. I mean, we have rent to pay, and every dollar that I have to lock up in a retirement account is one more dollar that I don’t get to enjoy right now. So why should I even bother?

It’s All About How You Look at It

Most authors, when they talk about saving for retirement, say things like “if you saved $1,000 today, if it returned 10% every year, in 40 years you’d have $45,259.26!”. Although that’s an impressive number, that’s most of your life you’d have to wait to enjoy that money. Plus, if you’re earning between $15,000-20,000 a year, that’s a pretty significant chunk of your yearly income that you’d have to sacrifice. I mean, that’s a couple months rent depending on where you live, or a nice TV.

So instead of thinking about the initial investment and the end result, instead think of it in a different way: the amount your salary would go up per year.

For the sake of discussion, let’s say you only invested in the Morgan Stanley High Yield Fund (NYSE: MSY), a closed-end fund traded on the New York Stock Exchange and managed by the investment bank Morgan Stanley. The way closed-end funds work is that they generate money for the fund managers to invest through their initial public offering, or IPO. In the IPO, the investment bank says “we’re going to sell X number of shares for Y dollars”, and the amount of money that the fund managers get to invest is simply X*Y. The NAV value, or net asset value per share, is the current value that the assets in the fund are trading for in the market, divided by the number of shares outstanding. Because the shares of the closed-end fund are then listed on an exchange (in this case the New York Stock Exchange) and traded daily, there is the NAV value per share, and the share price that the fund is currently trading for.

It’s somewhat complicated, but basically when you look at a site like ETF Connect, you just need to see whether it’s selling at a premium or discount to the NAV. Discount means you’re getting more bang for your buck, premium means you’re getting less bang for your buck. In the case of MSY, it is currently trading at a discount of 14.17%. That means you’re getting $1.14 in assets for every dollar you spend buying shares.

So How Will It Impact Your Earnings?

Back to my scenario. So the fund closed at $5.15 per share on Friday, and it yields a $0.035 dividend every month except for an almost $0.10 dividend the last month of every year. For the sake of discussion, I averaged them out to get a per month dividend of $0.04. So imagine this: you’re making $15,000 a year, and instead of being able to save that $1,000, you can only save $500. So you go find a broker, and you tell him you’d like to buy 97 shares of MSY (it’d probably be less in real life because of commissions). Now you’re invested.

Now assume that you automatically reinvest the dividends (the $0.04 paid out every month per share). Depending on your brokerage firm, they’ll let you buy partial fractions of shares (you want to make sure your brokerage allows it). Assuming all this, how much would you end up with at the end of year? Well, I did the calculations for you, and I came up with this: in one year, you’d have 106.44 shares, and if you say it’s still trading at $5.15, that’s $548.15, or a return of 9.7%. That $48.15 is your return, your additional income if you will. At the end of that first year, instead of earning $15,000, you earn $15,050. Now, that’s not a whole lot, but have you every heard of a TV that pays you? Didn’t think so.

All things staying the same, if you invest another $500, that’ll earn you an extra fifty, and for the second year, that first $500 will earn you an additional $53. That’s a total of $103 that you’re earning in addition to your normal income!

The Bottom Line

For me, I find this type of analysis to be really helpful in justifying your savings and investments. Imagine how much more you’d be making if you invested $1,000? $2,000?

Instead of thinking of it as money you’re never going to see again, think of it as you gradually increasing your own earning power! If you’re only making a little above or under $20K, you can invest in just a normal, standard portfolio (not an IRA) in which taxes apply, but you can access the money whenever (with that small of an income, your taxes won’t be that big anyways, although an IRA would still be better).

Wealth is built over time, so in the meantime, just focus on the additional money you’re earning because of your discipline and slight sacrifice.

If you’d like to see an article I wrote on Municipal debt, which is exempt from federal taxes (this is better for a regular, taxable portfolio) you can click here. Stay tuned for an upcoming article in which I talk about what brokerage firms are the best. In the mean time, if you’re just interested in learning a little bit more about investing, check out Seeking Alpha, a great site for investing pros and beginners alike.

Questions? Comments? E-mail me at thesaneinvestor@yahoo.com

All material copyright

© 2008 Andrew Jarmon

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