The Stock Market Holiday Party
Holy Tentacles! Have you looked at the stock market recently? In the span of two weeks my portfolio shot-up by 10%. That’s incredible!
The stock market is having a holiday party, and we’re all invited! But what exactly is moving this crazy market? Is it tax changes? Is it politics? Should we even care?
Tax Cuts & Stock Prices
Usually I try to avoid discussing current politics on this blog, but there’s just soooo many news articles attributing recent market gains to upcoming tax legislation. It’s really hard to ignore.
In United States, major corporations (those that actually pay taxes) typically pay a 35% corporate tax rate. A proposed change to tax laws would lower that corporate tax rate to 20%.
If the media is right about this tax legislation, then companies paying the highest corporate tax rates should have seen larger stock gains last week. Conversely, tax avoiders would have seen little-to-no stock market gains.
Stock prices could rise around 10 to 15% and still be valued at ‘normal’ levels. Is it actually happening?
Actually, yes! Tax paying companies, like Southwest Airlines (one of my favorite individual stock holdings) have risen nearly 10% in the last week. Meanwhile tax avoiders like Microsoft or Facebook haven’t seen similar market gains:
It’s not just tech companies or airlines effected either — Industrial stalwarts like GE and PSX saw very similar price behavior:
GE is a notorious tax avoider, often paying no corporate taxes. Meanwhile, PSX pays a 32% corporate tax rate. As you might expect, PSX’s stock rose last week.
I made these same comparisons using dozens of stocks, and saw very similar results — Taxpayers rose, and “non-payers” didn’t.
While it’s extremely interesting, none of it matters! Trying to make stock bets based on proposed political changes is just gambling.
It’s very possible stock prices will fall again next week if the tax changes don’t happen. Does it worry me? Nope!
Do I stress know the value of my portfolio value could change +10% or -10% on the whim of a politician?
Not one bit…
Keep Calm And Eat Well
In the face of such investing uncertainty, I always try to remember a few simple investing tips to keep my head in the right place…
Important Tip #1: Eat something incredibly delicious, and forget about the stock market nonsense.
Not everyone has this relaxed view of the markets however… Some people actually care what the stock market does day-to-day.
These same people probably believe the market is efficient and they should keep pumping in cash at any price.
Yeesh… if I believed that nonsense, I’m almost certain my business school professors would demand my hard-earned diploma back!
The Equity Bond
Another good trick I use to keep myself divorced from the emotional swings of the market is Important Tip #2: Remember The Equity Bond.
Equity what hu-ha-ha? Don’t worry, it’s not all that complicated.
The idea of The Equity Bond is simple — Instead of believing stocks are little pieces of paper that swing wildly in price day-to-day, imagine your stocks are really just perpetual bonds without a maturity.
Like traditional bonds that pay-out coupons, equity bonds also pay a stream of coupons. These coupons are the businesses’ earnings. Those earnings either get paid as dividends, or get reinvested for future earnings growth. If corporate earnings rise, then so will those equity ‘coupons’.
Make sense? It might be easier to wrap your head around the equity bond concept after a few drinks. Go ahead, I’ll wait…
Bond owners sleep well at night mainly because they’re in it for the coupons (aka dividends). They also hold those bonds for an extremely long time.
Investors in stocks or index funds would do well to adopt this relaxed attitude by remembering we aren’t investing in stocks because we desire the market value to rise. Nope! We’re in it for the growing earnings stream from the business (aka the coupons).
This is exactly why I talk about earnings yield so often — If we intend to hold stocks or index funds until death, we never need to sell. We simply live off the endless stream of ‘coupons’ from our equity bonds.
Don’t Forget Mr. Market
This brings me to the next helpful tip — Important Tip #3: Mr. Market is just a crazy neighbor.
Mr. Market is probably one of greatest investing ideas ever created. It originates from a book called The Intelligent Investor. (Great book BTW!)
I’ve written about Mr. Market before, but the importance of this idea bares repeating.
Imagine you own a farm. You grow vegetables on the farm, and the earnings pay for your livelihood. It keeps you well fed, and it’s a pretty good life.
Next door is another farm owned by your neighbor named Mr. Market. This neighbor is a little crazy.
Every day Mr. Market walks over and offers to buy your farm. The price he offers varies wildly from day to day — Some days the price is fair, other days it’s ridiculously cheap or expensive.
Here’s the thing — Most of the time you can safely ignore any price Mr. Market has to offer.
You’re a farmer, not a hunter. The only reason why you would possibly want to sell to Mr. Market is if…
- He’s offering a price so outlandishly high you’ll never need to farm again.
- You desire to trade your current farm for a better farm.
Simple, right?
Investing in the stock market is really no different from owning that farm. Instead of owning ‘farms’ of course, we own small bits of very big businesses.
Mr. Market (aka the stock market) is going to offer us prices for our businesses, but the vast majority of the time we should simply ignore him.
Valuations and FI
If you’ve already FIREd, ignoring the gyrations of the market is an important skill for long term success. Don’t let crazy Mr. Market convince you to make stupid moves. Remember, you’re in this game for the long-term earnings stream.
But what if you’re not already financially independent? What if you need to invest new dollars into the stock market today?
If that’s the case, then I recommend caution. These price levels are pretty high.
Why? Think back to that earnings stream. If you plan to live-off the 4% rule, the 3.95% earnings yield of the S&P 500 might be cause for concern. There’s very little room for error if earnings don’t grow rapidly.
Are earnings growing rapidly? You should probably decide for yourself.
This is why I think everyone should think twice about the 4% rule. Earnings don’t always go up year after year. There’s always blips. Recessions do happen. Why would you want to cut things this close?
Sequence of returns risk is a real issue for the financially independent — If you ‘retire’ at the wrong time, you could end-up eating into precious capital.
Like a good surfer, I recommend catching the wave at the right time to avoid these problems. If you time things right, you’ll end-up spending far less than your ‘farm’ produces.
That’s a recipe for success!
While I’d probably recommend timing the wave as to when you retire, I don’t necessarily agree with timing your investments (perhaps that wasn’t your intent but I read it like that.). Holding longer ultimately gives the best return, so extending your time horizon is the best course of action in my opinion.
Nope, I was merely advising caution. If you need to spend 4% today, a 3.95% bond with a potential serving of ‘coupon growth’ might not get you there. Maybe after a decade of growth…
Mmmmm….. shrimp tacos…..
Great post! I had not been taking notice of which companies tend to evade taxes versus pay them, but it’s a very interesting dynamic that you show in the data. I have a math oriented mind, so I tend to love to look at data and graphs etc. This poses a dilemma, because as you stated, it’s best to just ignore the market and be confident that if you keep investing your money you’ll be fine.
But darn it, I like to look at data!
We’re the same Accidental Fire. This kinds of data consumes my analytical side. On the other hand, I also know I need to “stay the course”. Be a farmer, not a hunter I remind myself.
Yeah, the market is getting wild lately. It has been great this whole year. I don’t know how long this will be, though. I agree with you: when investing new money into this market, take caution. At this moment, I don’t plan to do anything. Just watch the market, probably have some ice cream, and enjoy the coming holiday.
Solid plan Helen!
I like your style, Mr Tako. Life is too short to not enjoy great food and beverage! The market sure is on a crazy tear. While I would love a bit of a correction, I’ve learned to not sit idle too long and wait. I do have funds ready if it does though. We have a ways to go before FI so we are on the offensive. Take care sir!
If you have a large number of years before FI, growth can solve a large number of valuation “problems”. That said, these tiny future returns do not amuse me!
Great analogies! As fun as it is to watch the bull market if those tax cuts don’t go through, it could easily come plummeting back down, so absolutely agree with you to just ignore it and eat some tacos…or in my case Bun Cha. what I’ve learned from the whole Trump rally is that you absolutely can’t predict the market. I was CONVINCED we were going to be in a market freefall after the election last year but I was wrong. So don’t time the market. Now excuse me while I go get some nom noms.
Excellent plan FIRECracker!
Gosh you write so well! I like the use of the words divorced and gyrations in investing context lol! I also liked your mr market analogy because I don’t remember it being likened to buying a farm when I read Intelligent Investor.
I am also a proponent of not relying on the 4% Rule and am of the mindset of not touching your principle.
GYM recently posted…PF Blog Round Up: I Need to Buy a Lottery Ticket Edition
Thanks GYM!
I early retired right where you drew the red arrow in Catching the Wave, lol.
Back then investing for dividends was really popular. Dividends were cut drastically and many were completely suspended.
Finance blogging was popular then too.
At the end of the day we can’t control the market so all we can do is apply some common sense and remain vigilant. We are FIREing at 2.5% so hopefully we should be in good shape if the market drops, although only about 1.5% is coming from dividends, so we do have to take a small drawdown from our lower risk investments.
It sounds like you’ve thought it through pretty well Steve! 2.5% is pretty conservative, so if/when the market takes a dive you should be in pretty good shape.
Best of luck to you!
Thanks for providing our stimulating breakfast table conversation this morning Mr.Tako! Although it wasn’t tacos (or waffles for that matter), our egg & sausage sandwiches with a side of Mr.Market discussions were delightful.
Glad you enjoyed it Mrs. Wow! I thought you guys ate Waffles all the time? Maybe that’s just a Wednesday thing…
Yeah, this has been a bit crazy. I can’t believe it.
Then I just go back to my beer. MMMMM Beer… That beer looks tasty. Or I worry about what I’m having for dinner. Or where we’re traveling next.
Point being, just make sure you’re flexible. And don’t inflate everything because of some massive run up.
Massive run-up is right. My eyes are literally popping out of their sockets from the gains I’ve seen this last week.
Absolutely nobody should think this is “normal”. Retiring on 4% of a portfolio valuation today is absolute lunacy.
Now, enjoy that beer MrWow! Cheers!
“Important Tip #1: Eat something incredibly delicious, and forget about the stock market nonsense.”
I like this tip. And I like the photo too!
Mr. FAF and I have invested only a bit of money into our 401(k). I check the interest rates every once in a while, but I honestly don’t really care about it that much since I can’t touch the money anyway. Our fear right now is that we might lose our job if the market is not doing well. All the more reason why we should try to FIRE asap! ^.^
Nice post, Mr Tako. I love the intersection between humor, food, and education.
You are correct about the equity bond. Investors should be compensated for the extra risk they are taking as equity holders get wiped out before bond holders in the capital structure. Like take GE, reporting a shocking quarter of horrible cash flow followed by a restructuring plan and 50% dividend cut. The bond holders were left intact.
Like you, I’m doing nothing but accumulating cash slowly. My company had a reorganization and I was impacted so even though I received a good severance (technically am still on till the end of the year) I’ll need to go into cash conservation mode for a little while.
Cheers!
Mike
Great post Mr. Tako. While I was confident that the “tax talk” was significantly impacting the market, I hadn’t thought that just those high tax paying companies were the beneficiaries. Now that you mention it, it seems so obvious!
As someone who was just recently fired from the company they ran (receiving a payout in exchange for my equity), I am in a fortunate position to FIRE, should I so choose. At this time, I’m choosing to incorporate your strategies #3, #4 and because I was forced to, #5 from your outstanding “catching the wave” post. Not to suck up, but that post really laid out the strategies nicely for me and helped to realize all was gonna be ok with my cash.
Thanks for the help,
Dan
Nice post Mr. Tako. This market has been insane recently. Interesting research you performed and I’m not surprised. There are so many companies that have mastered not paying taxes. What I’m excited about is the potential of all the cash that has been stashed overseas to start returning back. Since our rates would potentially be lower, there is less of a benefit to hold the cash in lower taxed countries. And if the cash can be re-repatriated, I”m sure dividend investors will be jumping up and down.
I tend to ignore the impact of politics. One thing I have learned is to not over-react until the final bill is signed haha Because this thing could change 50 times before or heck, it might not even pass. But in all seriousness, since I focus on picking strong companies that have survived and paid a growing dividend through many economic cycles (to the best of my ability), I am less concerned on the short term impact that a tax bill or a political decision may have. Proven companies with strong management teams will adapt and find ways to continue remaining profitable regardless of the political environment.
Thanks again for the great read.
Bert
Well said Dividend Diplomats! Glad you enjoyed the post! 😉