Your Investing Questions Answered

Interest rates, AMC, stock picking, and more.

I recently asked readers to send in any questions they had about investing and the markets and I got some great responses. Please feel free to ask more questions in the comments.

The Federal Reserve approved an interest rate hike for the first time in three years … Can you help me understand the economic impact of this increase (along with the other three planned for this year)? – Josh

This has been a long time coming. In fact, it’s long overdue. Inflation has reached crisis levels while money is still cheap (i.e., cheap to borrow). The Fed raises rates to make money more expensive and slow down the speed at which it changes hands. If it’s harder to get money, it’s harder to spend it, which should slow down inflation, but also slow down the economy.

It’s important to note that the Fed Funds Rate only covers very short-term lending. In fact, it’s the “suggested” rate that banks loan money to each other overnight. Maybe even more important than the Fed raising the overnight rate is the fact that the Fed is also planning to reduce its balance sheet.

Earlier this week Fed Governor Lael Brainard said that the Federal Open Market Committee (FOMC) will “continue tightening monetary policy methodically through a series of interest rate increases and by starting to reduce the balance sheet at a rapid pace as soon as our May meeting.”

Here's the best chart that I could find showing the current status and breakdown of the Fed’s balance sheet. The Fed currently holds nearly $9 trillion in assets on its balance sheet. About $5.7 trillion of that is in “U.S. Treasury and Agency Securities.” Most of the rest of it is in mortgage-backed securities (MBS).

When Governor Brainard came out and said that the FOMC would reduce its balance sheet rapidly, as soon as May, she meant that the FOMC will start selling U.S. Treasuries. That sent Treasuries crashing and yields rising. Mortgage rates are rising too.

The FOMC is pulling multiple levers here. They are raising short-term interest rates via the Fed Funds Rate, and they are raising long-term interest rates by selling the Treasuries and MBS that they hold on their balance sheet. (You can also see why long-term rates are artificially low today – because the FOMC has bought trillions of dollars of Treasuries.)

So, what does this all mean for us? We’ve been living in an era of easy money. Home loans have been cheap for individuals, and corporate loans have been cheap for corporations. That era of easy money is over. Mortgages are going up. Margin rates are going up. Student loans are going up. Anywhere that we borrow money is going to get more expensive.

It also means that it’s going to be harder for equities to keep going up because capital can now earn a better return just by sitting in interest bearing investments. It’s particularly harder for the equity in technology companies to keep going up because growth sectors, like technology, are priced on the cash flows that they will generate in the future as opposed to the cash flows that they are generating today. Those future cash flows are less valuable when inflation is eating away at them year after year.

What this means for us is that real assets (things that you can buy and use today, like land and commodities) are going up, while financial assets (i.e., future cash flows) are going down because their future value is less certain.

AMC announced they purchased 22% of Hycroft Mining … I know you have talked about investing in GLD in the past; does this move change your perspective on AMC? – Josh

What does the CEO of a movie theater company know about the gold mining business? This is completely unhinged. We’re increasingly living in what I’d call fiat-world today. Value is whatever the influencers say it is. This is financial Dadaism.

How do I make use of the standard deviation data within the app? – Mike

Let’s talk about what a standard deviation is for just a minute. It’s an important concept to wrap your mind around. As the name suggests, a standard deviation is the most common deviation. Take this histogram of the $SPY, for example:

The mean (or average) daily percent return of the S&P 500 over the past year was 0.05% (which is right in that big green bar in the middle). That wasn’t the return every day though. In fact, the S&P 500 returned 0.05% on only one day of the past year. It’s just the average return.

All of the other days of the year, there was a deviation from 0.05%. The standard deviation was 0.94%. That means that most days were between -0.89% and +0.99%. If we count the number of days in the past year that fell in that range, it’s 179 days out of 251. That’s about 70% of the days.

So, if you know what your average daily return is, and you know what your standard deviation is, you know that most of the time your daily returns will be within +/- one standard deviation of your average return.

Here’s the chart of standard deviation for the S&P 500 over the past year:

Looking at this chart, it’s also interesting to note that the standard deviation bottomed in late November around 0.75% and has been on the rise ever since. This means that the volatility in the S&P 500 is increasing.

Do you think volume data can help assess the dScore, Risk Efficiency, and Growth? – Mike

Volume data can be very interesting, but it’s a separate topic of study. I’ve found it useful in the past to look at how much volume has occurred at different price levels. This is called volume-at-price data. It can help identify good support and resistance levels.

How does one scan for stocks that fit the desired risk profile? – Jacques

The great thing about thinking in terms of a portfolio rather than thinking only in terms of individual investment opportunities is that it opens up a new world of investment opportunities. Even if you’re conservative, you could still consider investing a small amount of money in a very risky venture – especially if that risky bet is minimally correlated to the rest of your portfolio.

My favorite way to find new investment ideas is to gather up all of the ideas that I might be interested in and then sort them by how correlated they are to my existing portfolio. I then look for interesting ideas that will increase my Risk Efficiency and lower my dScore.

We’re working on a new feature in RiskSmith right now that we’re calling Collections. A Collection is a group of investment ideas that you are interested in. You can gather ideas from all kinds of sources and add them to your Collection.

We’re also working on a browser plug-in that lets you easily add something interesting to your Collection from any online page. Come across an interesting idea on a webpage? Click on it and add it to one of your Collections.

Once you have a Collection, you can rank the investments in your Collection by how much diversification they’ll give to an existing portfolio.

If you have less than $1,000 to invest, should you attempt to invest? – D’Airus

With fractional share ownership and no commissions, I think that it’s very doable today. Moreover, you have to be in the market in order to begin to get a feel for the market. Paper trading just doesn’t cut it. My favorite broker for investing small amounts of money is M1 Finance. Tell their CEO Brian Barnes that I sent you.

What signals would you need to have clearly defined to confidently enter a long position in the near future? Short positions? – Matt

You need to ask yourself how long you’ll be looking to hold the position? Some positions I’m in and out of in a few hours. Some positions I intend to hold for a decade or more.

I assume you’re interested in my thoughts on whether or not the S&P 500 is a buy or a sell right now. Overall, I’m leaning bullish at these price levels, but I am completely prepared to see lower prices before the year is out.

I’m bullish because we’ve seen impressive and broad strength in the markets since the bottom on March 14.

When all is said and done, we have to listen to what the markets are telling us.

That strength cannot be denied, but there’s no doubt that there’s increased event risk in the markets today.

When I look at the world around me, both locally and globally, I’m alarmed by what I see. A close in the S&P 500 below 4,100 would turn me very bearish. For now, though, the bulls have the edge.

There’s no doubt that there’s increased event risk in the markets today.

Does swing trading have merit, and would you use this to take profits, enter short/long positions on a longer-term time frame, e.g., weekly charts? – Matt

Swing trading absolutely has merit if you really study it and work it. The key is to have discipline in whatever you do. Discipline is what really separates the winners from the losers. As Jack Schwager said about the Market Wizards, every one of them is completely different, but they all are pretty religious about risk management.

Virtually every trader I ever interviewed said the risk management part is more important than the method. – Jack Schwager, Author of Market Wizards

How do we optimize the growth of the asset (cash) we currently hold in these market conditions with the view to be the best steward of it for the future of our children and others (I’m 54 years old)? – Matt

The first thing is to have a clear idea of what kind of future you want for your children. Do you just want them to have money, or do you want them to have something else? I’m 54 too, and I’m thinking more and more that my own children need my time more than my money. Cash in the bank can buy some time.

After that, I really try to think about whether or not the companies that I would consider investing in are doing something that I think my own children could benefit from. That makes it impossible for me to invest in predatory enterprises no matter how good their returns are.

I really try to think about whether or not the companies that I would consider investing in are doing something that I think my own children could benefit from.

Can you analyze this stock for long position, or teach me how? Or is there something I didn’t see? (VPLM, just above 2 cents, was bought 2013.) – Timothy

This is a penny stock fighting an uphill legal battle to claim VoIP technology patent violations against the likes of Apple, Twitter, and AT&T. It looks like they lost their initial round of cases about four or five years ago and are in the process of appealing. Fighting legal battles with deep-pocketed adversaries is a tough business model. Any money put into a stock like this should be regarded as a lottery ticket. You expect to lose. You don’t lose sleep over it. If you win, it’s a shock and a life-changing event.