The Investing Club is all about education. So when we receive multiple questions on a topic from members — and one unenlightened editor — we have some explaining to do. A question that’s been popping up lately: What do the pros mean when they talk about “demand destruction” and why is it so incredibly important we get some? We hear you, but before we can discuss the concept in more detail, we must first understand how prices are determined. Welcome to Economics 101. At the heart of all economics is supply and demand. That goes for the labor market, and it goes for a market of goods such as, say, semiconductors or oil. How prices are fixed for that labor or those goods will always come down to basic supply and demand. This concept can best be illustrated using a series of pricing graphs. Supply & Demand — free market On the Y-axis (the vertical one on the left) we have price. On the X-axis (the horizontal one on the bottom) we have quantity. The demand line slopes from the upper left to the bottom right, and the supply line goes from the bottom left to the upper right. The intersection of those two lines (demand and supply) is where we find “equilibrium.” In a totally free market — that’s unrestricted by supply chain bottlenecks and doesn’t have things like taxes or subsidies impacting demand — that equilibrium point determines the quantity (Q1) suppliers will produce and the price (P1) buyers will pay. The issue we face today: While demand has remained elevated and steady, supply has become tighter due to breaks in the supply chain. This break can be found all over the global markets: semiconductor production, not enough oil production, China’s Covid shutdowns, labor shortages, and so on. To illustrate this tight supply, we shift our supply line to the left as moving left on the X-axis indicates a lower quantity of supply. Supply & Demand — supply constrained market As we can see above, this small shift in supply — with no change in demand — creates a new equilibrium point at which we see a higher price level (P2). There are only two ways to get prices back down from the P2 level toward the original P1 level (or at the very least stop prices from rising even higher). One option is to increase supplies again — a move that will bring us back to the old equilibrium, or at least a point close to it. The other is to destroy demand. The first option is out: There is nothing the Federal Reserve can do to increase supply. It can’t force China to open its factories or make more container ships appear out of thin air. Therefore, the only option left is to destroy demand. How is that done? By draining liquidity out of the market through interest-rate hikes (which impact shorter-term rates) and a reduction in open market purchases of bond securities (which impact longer-term rates). The Fed needs to pull dollars out of the economy and raise the cost of borrowing — the exact opposite of what happened in 2020 with the economic stimulus. Supply & Demand — supply constrained with demand destruction By lowering demand, we can reach a new equilibrium level (marked in red). Here we find lower prices (P3) that are in line with the quantities suppliers can produce in this current environment. We can destroy some demand to meet the lower production of supplies. We also achieve the goal of bringing down prices (or at the very least reducing the rate of inflation). This is how the current Fed is trying to bring inflation back down to its 2% target rate. Whether this can be done without pushing the economy into a recession, by achieving a so-called soft landing, remains to be seen. But in the long run, we’re better off in a temporary recession than an economy with runaway inflation. This results in the destruction of buying power that’s incredibly difficult to rebound from. ‘Demand elasticity’ One last concept that impacts how we approach investing in this market when we know the goal is to reduce demand, is to be very mindful of “demand elasticity,” or the change in demand resulting from a change in price. If a good is very elastic, it means the consumer can do without it and will quickly demand less as the price rises. On the other hand, if a good is highly inelastic, it means that the consumer will pay the increased prices and minimal demand will be lost. One example of an elastic good is soft drinks; at some point, most consumers just aren’t going to keep paying up for a bottle of soda. Sure, they may accept a small increase here or there but at the end of the day, it is a luxury that most can survive without. This is why the Club seeks out companies that have pricing power, even in bad economies. Conversely, lifesaving medication — like drugs manufactured by Club names Eli Lilly (LLY), AbbVie (ABBV) and Johnson & Johnson (JNJ) — is about as inelastic as it gets. Even if prices were to double, most consumers will cut other expenses (like soft drinks) first to ensure they can stay healthy. Energy is another example of an inelastic good, since it’s not only required to get around but also serves as the main means of producing most goods. That’s where oil and natural gas names — including Club holdings Pioneer Natural Resources (PXD), Devon Energy (DNV) and Coterra Energy (CTRA) — can benefit. Consumer staple stocks also have a degree of inelasticity, and Club name Procter & Gamble (PG) is the powerhouse of the group. While P & G does run the risk that people will turn to cheaper toothpaste, laundry detergent and shaving products, we believe its superior brands such as Crest, Tide and Gillette allows it to raise prices to combat business cost inflation without appreciable loss of market share. Although these products may come at a higher upfront costs, investments in innovation can actually make them more competitive on a per-use basis Even cloud computing and cybersecurity would represent examples of inelastic goods, though perhaps not to the same extent as life-saving medication. Cloud computing is fast becoming the backbone of global productivity. Good luck running a business if your data is hacked into regularly. Our Club names with robust cloud units include Amazon (AMZN), Alphabet (GOOGL) and Microsoft (MSFT). To be clear, some businesses of these companies are more elastic. Think Amazon’s e-commerce unit, Alphabet’s hardware business, or Microsoft’s personal computing segments. Many of our other tech holdings are exposed to the cloud, including Salesforce (CRM), which offers cloud-based solutions that help companies run their businesses more efficiently. Then there are those goods that fall somewhere in the middle of the elasticity spectrum. One example is iPhones. Brand loyalty provides Club name Apple (AAPL) with significant pricing power, but it’s not the inelasticity found for oil or medication. When times get tough, iPhone consumers may look to extend the life of their phones. So, while we certainly maintain our “own it, don’t trade” view of Apple, we must be mindful that in these uncertain times, broad demand destruction can impact sales for even the greatest consumer products. Bottom line Companies that boast inelastic goods are where we want to focus our buying power in the face of uncertainty and a Fed intent on destroying demand. That is why we continue to focus heavily on energy, healthcare, and consumer staples — taking shots at other sectors only when the long-term value is too great to ignore. These are usually companies we believe will ride out a tightening cycle and are positioned to capture an outsized amount of economic activity once we recover. (Jim Cramer’s Charitable Trust is long AAPL, ABBV, JNJ, LLY, PXD, DVN, CTRA, AMZN, GOOGL and MSFT. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.
China still holds the cards for global supply chains, whether or not Covid lockdowns frustrate businesses in the near term. An employee works on the production line of the screens for 5G smartphones at a factory on May 13, 2022 in Ganzhou, Jiangxi Province of China.
If pension funds can't see the case for investing in Canada, why should you? – The Globe and Mail
Published
13 mins ago
on
April 19, 2024
By
It’s time to ask a rude question: Is Canada still worth investing in?
Before you rush to deliver an appropriately patriotic response, think about the issue for a moment.
A good place to begin is with the federal government’s announcement this week that it is forming a task force under former Bank of Canada governor Stephen Poloz. The task force’s job will be to find ways to encourage Canadian pension funds to invest more of their assets in Canada.
Wooing pension funds has become a high-priority matter for Ottawa because, at the moment, these big institutional investors don’t invest all that much in Canada. The Canada Pension Plan Investment Board, for instance, had a mere 14 per cent of its massive $570-billion portfolio in Canadian assets at the end of its last fiscal year.
Other major Canadian pension plans have similar allocations, especially if you look beyond their holdings of government bonds and consider only their investments in stocks, infrastructure and real assets. When it comes to such risky assets, these big, sophisticated players often see more potential for good returns outside of Canada than at home.
This leads to a simple question: If the CPPIB and other sophisticated investors aren’t overwhelmed by Canada’s investment appeal, why should you and I be?
It’s not as if Canadian stocks have a record of outstanding success. Over the past decade, they have lagged far behind the juicy returns of the U.S.-based S&P 500.
To be fair, other countries have also fallen short of Wall Street’s glorious run. Still, Canadian stocks have only a middling record over the past 10 years even when measured against other non-U.S. peers. They have trailed French and Japanese stocks and achieved much the same results as their Australian counterparts. There is no obvious Canadian edge.
There are also no obvious reasons to think this middle-of-the-pack record will suddenly improve.
A generation of mismanagement by both major Canadian political parties has spawned a housing crisis and kneecapped productivity growth. It has driven household debt burdens to scary levels.
Policy makers appear unwilling to take bold action on many long-standing problems. Interprovincial trade barriers remain scandalously high, supply-managed agriculture continues to coddle inefficient small producers, and tax policy still pushes people to invest in homes rather than in productive enterprises.
From an investor’s perspective, the situation is not that appetizing. A handful of big banks, a cluster of energy producers and a pair of railways dominate Canada’s stock market. They are solid businesses, yes, but they are also mature industries, with less than thrilling growth prospects.
What is largely missing from the Canadian stock scene are big companies with the potential to expand and innovate around the globe. Shopify Inc. SHOP-T and Brookfield Corp. BN-T qualify. After that, the pickings get scarce, especially in areas such as health care, technology and retailing.
So why hold Canadian stocks at all? Four rationales come to mind:
Canadian stocks have lower political risk than U.S. stocks, especially in the run-up to this year’s U.S. presidential election. They also are far away from the front lines of any potential European or Asian conflict.
They are cheaper than U.S. stocks on many metrics, including price-to-earnings ratios, price-to-book ratios and dividend yields. Scored in terms of these standard market metrics, they are valued more or less in line with European and Japanese stocks, according to Citigroup calculations.
Canadian dividends carry some tax advantages and holding reliable Canadian dividend payers means you don’t have to worry about exchange-rate fluctuations.
Despite what you may think, Canada’s fiscal situation actually looks relatively benign. Many countries have seen an explosion of debt since the pandemic hit, but our projected deficits are nowhere near as worrisome as those in the United States, China, Italy or Britain, according to International Monetary Fund figures.
How compelling you find these rationales will depend upon your personal circumstances. Based strictly on the numbers, Canadian stocks look like ho-hum investments – they’re reasonable enough places to put your money, but they fail to stand out compared with what is available globally.
Canadians, though, have always displayed a striking fondness for homebrew. Canadian stocks make up only a smidgen of the global market – about 3 per cent, to be precise – but Canadians typically pour more than half of their total stock market investments into Canadian stocks, according to the International Monetary Fund. This home market bias is hard to justify on any rational basis.
What is more reasonable? Vanguard Canada crunched the historical data in a report last year and concluded that Canadian investors could achieve the best balance between risk and reward by devoting only about 30 per cent of their equity holdings to Canadian stocks.
This seems to be more or less in line with what many Canadian pension funds currently do. They have about half their portfolio in equities, so devoting 30 per cent of that half to domestic stocks works out to holding about 15 per cent of their total portfolio in Canadian equities.
That modest allocation to Canadian stocks is a useful model for Canadian investors of all sizes. And if Ottawa doesn’t like it? Perhaps it could do more to make Canada an attractive investment destination.
Want to Outperform 88% of Professional Fund Managers? Buy This 1 Investment and Hold It Forever. – Yahoo Finance
Published
4 hours ago
on
April 19, 2024
By
You might not think it’s possible to outperform the average Wall Street professional with just a single investment. Fund managers are highly educated and steeped in market data. They get paid a lot of money to make smart investments.
But the truth is, most of them may not be worth the money. With the right steps, individual investors can outperform the majority of active large-cap mutual fund managers over the long run. You don’t need a doctorate or MBA, and you certainly don’t need to follow the everyday goings-on in the stock market. You just need to buy a single investment and hold it forever.
That’s because 88% of active large-cap fund managers have underperformed the S&P 500 index over the last 15 years thru Dec. 31, 2023, according to S&P Global’s most recent SPIVA (S&P Indices Versus Active) scorecard. So if you buy a simple S&P 500 index fund like the Vanguard S&P 500 ETF(NYSEMKT: VOO), chances are that your investment will outperform the average active mutual fund in the long run.
Why is it so hard for fund managers to outperform the S&P 500?
It’s a good bet that the average fund manager is hardworking and well-trained. But there are at least two big factors working against active fund managers.
The first is that institutional investors make up roughly 80% of all trading in the U.S. stock market — far higher than it was years ago when retail investors dominated the market. That means a professional investor is mostly trading shares with another manager who is also very knowledgeable, making it much harder to gain an edge and outperform the benchmark index.
The more basic problem, though, is that fund managers don’t just need to outperform their benchmark index. They need to beat the index by a wide enough margin to justify the fees they charge. And that reduces the odds that any given large-cap fund manager will be able to outperform an S&P 500 index fund by a significant amount.
The SPIVA scorecard found that just 40% of large-cap fund managers outperformed the S&P 500 in 2023 once you factor in fees. So if the odds of outperforming fall to 40-60 for a single year, you can see how the odds of beating the index consistently over the long run could go way down.
What Warren Buffett recommends over any other single investment
Warren Buffett is one of the smartest investors around, and he can’t think of a single better investment than an S&P 500 index fund. He recommends it even above his own company, Berkshire Hathaway.
In his 2016 letter to shareholders, Buffett shared a rough calculation that the search for superior investment advice had cost investors, in aggregate, $100 billion over the previous decade relative to investing in a simple index fund.
Even Berkshire Hathaway holds two small positions in S&P 500 index funds. You’ll find shares of the Vanguard S&P 500 ETF and the SPDR S&P 500 ETF Trust(NYSEMKT: SPY) in Berkshire’s quarterly disclosures. Both are great options for index investors, offering low expense ratios and low tracking errors (a measure of how closely an ETF price follows the underlying index). There are plenty of other solid index funds you could buy, but either of the above is an excellent option as a starting point.
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John Ivison: The blowback to Trudeau's investment tax hike could be bigger than he thinks – National Post
Published
7 hours ago
on
April 19, 2024
By
The numbers from the Department of Finance suggest they have struck taxation gold. But they’ve been wrong before
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Published Apr 19, 2024 • Last updated 8 hours ago • 5 minute read
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“99.87 per cent of Canadians will not pay a cent more,” the prime minister said this week, in reference to the budget announcement that his government will raise the inclusion rate on capital gains tax in June.
The move will be limited to 40,000 wealthy taxpayers. “We’re going to make them pay a little bit more,” Justin Trudeau said.
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But it’s hard to see how that number can be true when the budget document also says 307,000 corporations will also be caught in the dragnet that raises the inclusion rate on capital gains to 66 per cent from 50 per cent.
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Many of those corporations are holding companies set up by professionals and small-business owners who are relying on their portfolios for their retirement.
The budget offers the example of the nurse earning $70,000 who faces a combined federal-provincial marginal rate of 29.7 per cent on his or her income. “In comparison, a wealthy individual in Ontario with $1 million in income would face a marginal rate of 26.86 per cent on their capital gain,” it says.
Policy wonks argue that the change improves the efficiency and equity of the tax system, meaning capital gains are now taxed at a similar level to dividends, interest and paid income. The Department of Finance is an enthusiastic supporter of this view, which should have set alarm bells ringing on the political side.
That’s not to say it’s not a valid argument. But against it you could put forward the counterpoint that capital gains tax is a form of double taxation, the income having already been taxed at the individual and corporate level, which explains why the inclusion rate is not 100 per cent.
The prospect of capital gains is an incentive to invest particularly for people who, unlike wage earners, usually do not have pensions or other employment benefits.
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That was recognized by Bill Morneau, Trudeau’s former finance minister, who said increasing the capital gains rate was proposed when he was in politics but he resisted the proposal.
Morneau criticized the new tax hike as “a disincentive for investment … I don’t think there’s any way to sugar-coat it.”
Regardless of the high-minded policy explanations that are advanced about neutrality in the tax system, it is clear that the impetus for the tax increase was the need to raise revenues by a government with a spending addiction, and to engage in wedge politics for one with a popularity problem.
The most pressing question right now is: how many people are affected — or, just as importantly, think they might be affected?
One recent Leger poll said 78 per cent of Canadians would support a new tax on people with wealth over $10 million.
But what about those regular folks who stand to make a once-in-a-lifetime windfall by selling the family cottage? We will need to wait a few weeks before it becomes clear how many people feel they might be affected.
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The numbers supplied to Trudeau by the Department of Finance suggest they have struck taxation gold: plucking the largest amount of feathers ($21.9 billion in new revenues over five years) with the least amount of hissing (impacting just 0.13 per cent of taxpayers).
The worry for Trudeau and Finance Minister Chrystia Freeland is that Finance has been wrong before.
Political veterans recall former Conservative finance minister Jim Flaherty’s volte face in 2007, when he was forced to drop a proposal to cancel the ability of Canadian companies to deduct the interest costs on money they borrowed to expand abroad.
“Tax officials vastly underestimated the number of taxpayers affected when it came to corporations,” said one person who was there, pointing out that such miscalculations tend to happen when Finance has been pushing a particular policy for years.
Trudeau’s government has some experience of this phenomenon, having been obliged to reverse itself after introducing a range of measures in 2017, aimed at dissuading professionals from incorporating in order to pay less tax. It was a defensible public policy objective but the blowback from small-business owners and professionals who felt they were unfairly being labelled tax cheats precipitated an ignoble retreat.
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Speaking after the budget was delivered, Freeland was unperturbed about the prospect of blowback. “No one likes to pay more tax, even — or perhaps more particularly — those who can afford it the most,” she said.
She’d best hope such sanguinity is justified: failure to raise the promised sums will blow a hole in her budget and cut loose her fiscal anchors of declining deficits and a tumbling debt-to-GDP ratio.
That probably won’t be apparent for a year or so: the government projected that $6.9 billion in capital gains revenue will be recorded this fiscal year, largely because the implementation date has been delayed until the end of June. We are likely to see a flood of transactions before then, so that investors can sell before the inclusion rate goes up.
After that, you can imagine asset sales will be minimized, particularly if the Conservatives promise to lower the rate again (though on that front, it was noticeable that during question period this week, not one Conservative raised the new $21 billion tax hike).
The calculated nature of the timing is in line with the surreptitious nature of the narrative: presenting a blatant revenue grab as a principled fight for “fairness.” The move has the added attraction of inflicting pain on the highest earners, a desirable end in itself for an ultra-progressive government that views wealth creation as a wrong that should be punished.
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Trudeau’s biggest problem is that not many voters still associate him with principles, particularly after he sold out his own climate policy with the home heating oil exemption.
The tax hike smacks of a shift inspired by polling that indicates that Canadians prefer that any new taxes only affect the people richer than them.
Success or failure may depend on the number of unaffected Canadians being close to the 99.87-per-cent number supplied by the Finance Department.
History suggests that may be a shaky foundation on which to build a budget.
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