Happy December! I wanted to write about one thing, but instead I’m using alliteration to talk about the three things I’ve been questioned about multiple times over the last week: 1) Bubbles: are we in one? 2) Bills: what is the effect of the pending tax bill that Congress is trying to pass? 3) Bitcoins: should we buy them?
The reason the question of a bubble keeps coming up is because the Dow Jones Industrial Average has continued to break through round-numbered (1,000 point) barriers this year. We like round numbers, and so we pay more attention to them as they come. But, when there are a lot of them, it causes talk of a bubble. However, this alone is not a bubble indicator. Why? Let’s talk math. When prices increase, it takes a bigger increase to equal the same percentage. If you are making $25,000 and you get a 20% raise, you now make $5,000 more, or $30,000. But let’s say you are making $100,000 and get a $5,000 raise; that is only a 5% raise. The same goes for the stock market, and so the best way to look at a chart of the stock market is logarithmically, which smooths out the chart as it equates the percentages over time. Here is a chart of the Dow Jones over the last 50 years, a timeframe for which most of us have been investing or at least have a memory of market levels; looking at this, the dramatic rise over the last 18 months looks extreme:
Here is the same chart, viewed logarithmically, so that (for example) a 10% increase in the 1980’s looks the same as a 10% increase today; in this chart, the steepest slopes (up) are during the mid-80’s and the late-90’s:
As you can see, a better way to discern bubbles are through corporate profits vs. stock prices; this leads us to:
First off, the House has passed a tax bill, and the Senate has passed a tax bill, and they are different. They must now be aligned somehow before having the opportunity to go to the President and becoming official. Therefore, discussing the final form is speculation, but let’s go ahead and speculate. The biggest negatives that keep making their way into the press is that many deductions are going away; this is true. However, what fails to make the news is that the standard deduction is rising, by a significant amount, roughly doubling. If you are in the minority and actually itemize, under the new standard deduction you likely wouldn’t need to itemize were the old allowable deductions still in place, and your taxes will be lower. A good website that lets you estimate your estimated future tax bill is here.
Now, back to corporate profits: the new tax plan is favorable to corporations. Under the trickle-down economics theory, this is good for the economy. I’m not going to comment on that theory because, sadly, nothing happens in a vacuum, so it’s really impossible to know how or if that theory has or will work, which is why it’s still called a theory. I do know, though, that when corporations have higher after-tax income, stock prices go up. This is why the market has been doing so well: as a leading indicator, the market is anticipating higher corporate profits because of the tax bill.
Bitcoins, Ethereum, Ripple, and other cyber-currencies are suddenly the talk of the town. These currencies should be viewed just like any other world currency, meaning as a medium of exchange with general use or acceptance. Viewing them in any other way is like viewing them as tulips, trading cards, or beanie babies, all of which have had dramatic run-ups and falls in history. I’m not saying you shouldn’t buy them, I’m just saying that, like anything else, you shouldn’t put all of your eggs in one basket. Like gold, they do have intrinsic value as they are technically ‘mined’ and there is a limited supply, but like gold they provide no income and are worth as much as someone is willing to pay. Unlike gold, though, is they are presently not very liquid as almost no retailers accept them. The other problem with them, just like any investment, is that there is an exchange fee; the less liquid an item, the larger that fee is, and it can be 10% (or more) of the value of the cyber-currency. So, if you buy it, you need for it to increase in value by that fee (call it 10%) just to break even!
This chart of the price of bitcoin shows how the price has grown dramatically, fast:
This truly looks like a bubble to me, and now we’ve come full circle back to paragraph 1! Have a great week, and make good choices!