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The Impact of Covid-19 on the Future of Interest Rates

No one could have predicted the onset of the novel coronavirus pandemic in late 2019 and early 2020. The virus spread across the planet in a matter of months with no real end in sight. It is safe to assume that investors from around the world need to think about a...

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No one could have predicted the onset of the novel coronavirus pandemic in late 2019 and early 2020. The virus spread across the planet in a matter of months with no real end in sight. It is safe to assume that investors from around the world need to think about a “new normal” going forward. For many, that means figuring how the future of interest rates will look post-COVID-19.
 
In the weeks that followed the arrival of the coronavirus, yields in the United States and Europe dropped to unbelievable lows. The returns on investments were now slim-to-none and recession could be on the horizon. While some fear that these low yields and even lower interest rates could bring widespread financial losses, problems with debt, and much higher inflation rates that will push interest to higher rates than the ones before Covid-19, others stand firm in the belief that interest rates will remain low long after the pandemic has disappeared. They are not guessing, either — there are plenty of good reasons for some experts to feel this way.
 

Looking back so we can look ahead

 
Because the novel coronavirus is exactly that — a new phenomenon — it is impossible to know what is going to happen in the months and years to come. For this reason, financial experts on either side of the debate have made educated theories about the future of interest rates. Truthfully, though, the best bet seems to be to look at past pandemics and the impact they had on the market. It will allow us to make the smartest predictions about our future post-COVID-19. To understand the future of interest rates, we have to look back at pandemics and interest rates over the last 70 years.
Recently, the San Francisco Federal Reserve Bank, economists Òscar Jordà and Sanjay Singh, and former PIMCO senior advisor Alan Taylor looked at 15 pandemics since the 14th century that resulted in the loss of over 100,000 lives. They concluded that, in each instance, the pandemic had a long-lasting impact on interest rates that kept them low for decades. Of course, there are limiting factors worth mentioning: These past pandemics had a significant impact on the labour force, effectively decimating the number of workers in relation to the capital. Covid-19 has mainly impacted older, retired people that only make up a small percentage of the modern workforce in the United States and the United Kingdom. Additionally, the fiscal response to the novel coronavirus is much larger than responses in past decades. Increase in money supply could lead to higher inflation and higher interest rates, not lower.
 

Estimating the long-term impact

 
Even without these two holdups mentioned in the previous section, there are a couple of other reasons to believe that the financial impact of the coronavirus on interest rates is likely to stay negative going forward. For starters, most businesses are expected to want to save their money instead of spending it to make up for the losses they experienced during Covid-19 shutdowns. It has happened in the past, most recently in the wake of the 2008 global financial crash. It seems fair to say that people will plan on saving instead of spending. All this saving will hopefully offset the high deficits that have plagued the world during the coronavirus pandemic. In addition to saving, it is fair to assume that banks in the U.S. and the U.K. will keep their short-term interest rates low. Not to mention, debt-to-GDP ratios will almost definitely go higher after the end of the Covid-19 pandemic. Thankfully, this all sounds a lot more complicated than it actually is. In reality, the United States has actually already done something similar in the past. In the wake of the Second World War, the U.S. government kept a cap on long-term Treasury yields (at 2.5%) that had been there since before the war began. It helped keep borrowing costs low during the following economic boom and subsequent increase in inflation. These new policies helped to keep the U.S.’s debt-to-GDP from doing permanent damage to the economy. Eventually, when inflation skyrocketed past 20% in the early 1950s, the government finally gained the ability to set monetary policy (commonly known as the Treasury-Fed Accord of 1951). Ideally, if North American and European countries follow a similar plan, the long-term financial impact will not be as severe as some of the less constructive alternatives some experts have predicted.
 

The bottom line

 
While this might sound like a lot of confusing economic jargon, the point is a lot less difficult to understand: it might feel like the Covid-19 pandemic is the first and only crisis of its kind in the entire history of the world, but the truth is that it’s just one of many similar situations the planet has already gone through. The novel coronavirus is certainly a unique pandemic, no doubt, but pandemics have come and gone in decades past and the economy has always found a way to thrive. There is no denying that Covid-19 is a crisis. It is not to be taken lightly, whether you live in the United States, the United Kingdom, or somewhere else entirely. From humanitarian issues to healthcare concerns to economic anxieties, the long-term impact of the pandemic will not just fade out. It is going to take some time to get back to “normal.” The good news is that, eventually (and hopefully sooner rather than later), the threat of the virus will go away. Based on the vast amount of evidence from the past decade, the coronavirus’ impact on interest rates will also be around for a while. With this in mind, investors should definitely prepare for an extended period of record low-interest rates for quite some time.
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What is the impact of lockdown on the price of crude oil?

On April 20, 2020, U.S. crude oil futures fell by 300% to an all-time low of -$40.32 a barrel for the first time in history. Two factors contributed to this decline: Firstly, crude oil storage was much too full. Secondly, refineries were running at historically low...

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On April 20, 2020, U.S. crude oil futures fell by 300% to an all-time low of -$40.32 a barrel for the first time in history. Two factors contributed to this decline: Firstly, crude oil storage was much too full. Secondly, refineries were running at historically low levels due to COVID-19 lockdowns. Now, with no relief from the pandemic, where is the oil price heading for the rest of 2020? To answer this, we need to understand what the main drivers of the oil price are: Supply, demand, and market sentiment.

Global Crude Oil Supply Trend

Since the start of the second quarter of 2020, oil production levels have changed significantly. Most OPEC and Non-OPEC nations have agreed to cut production levels — Some oil producers in the U.S. and Canada are forced to reduce production by 3.5 million barrels a day because of these historically low prices, while others have done it to offset the lower demand. For example, in May 2020, OPEC nations produced 24.77 million barrels of oil per day (down by 5.91 million barrels per day over the same period in April 2020).

During the same quarter, countries like India, China, Korea, and the U.S. created strategic storage solutions for up to 200 million barrels in an effort to take advantage of these lower oil prices. Altogether, these measures are sure to create a deficit in supply for the third quarter of 2020.

Global Crude Oil Demand Trend

Due to COVID-19, global oil demand fell by 9.3 million barrels per day. In April 2020 alone, (year-on-year) oil demand lowered by 29 million barrels per day. It is expected that, in Q2 or 2020, oil demand will be lower by 23.1 million barrels per day compared to Q2 2019. If lower demand is not met with cuts in oil production by OPEC, the U.S., and Canada, then the oil price will almost certainly take a hit.

Commodity Cycles and Market Sentiments

Crude oil prices have a short cycle of 6 years and a long cycle of 29 years. Other factors that affect market sentiment can be calculated by understanding the general position of hedgers and speculators in the futures market.

Market sentiment can be calculated from the futures position of hedgers and speculators. In the last week of May 2020, hedgers (i.e. oil producers) had more short positions (1,297,095 contracts) than long positions (725,955 contracts). On the contrary, speculators (i.e. traders) had more long positions (701,234 contracts) than short positions (158,660 contracts). If you combine the position of market participants with the market cycles, one can make a reasonable estimate of oil price movement.

EIA expects Brent crude oil prices will average at $32 a barrel during the second half of 2020 and $48 a barrel on average in 2021. However, this price path reflects an expected global oil consumption to 97.4 million barrels a day during the second half of 2020 along with relatively high compliance to announced OPEC production cuts, both of which are uncertain. The degree to which the U.S. shale industry responds to the current low prices will also affect the oil price path in the coming quarters.

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How to be on the correct side of COVID-19 stock market crash?

On November 17, 2019, a 55-year-old man in the Hubei province was tested positive for COVID-19, a disease caused by a novel coronavirus. His positive result started a series of events that led to lockdown in 50 countries and the biggest stock market crash of the 21st...

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On November 17, 2019, a 55-year-old man in the Hubei province was tested positive for COVID-19, a disease caused by a novel coronavirus. His positive result started a series of events that led to lockdown in 50 countries and the biggest stock market crash of the 21st century. Nothing can prepare us for a pandemic, but we can adapt our portfolio and lifestyle to changing times. Below are the three things you can do to prepare yourself. On November 17, 2019, a 55-year-old man in the Hubei province was tested positive for COVID-19, a disease caused by a novel coronavirus. His positive result started a series of events that led to lockdown in a dozen countries and the biggest stock market crash of the decade. Nothing can prepare us for a pandemic, but we can adapt our portfolio and lifestyle to changing times. Below are the three things you can do to prepare yourself.

Embrace for impact

Investors usually overestimate their risk tolerance. In a falling market, I would recommend deleveraging your portfolio and investing only the capital that you can live without for the next ten years. Another good discipline is to review your holdings timely and identify weaknesses within your portfolio. Stocks you do not want in your portfolio are cyclical companies. Cyclical companies (i.e. Airlines, Hotels, Financial Services and Natural Resources) are the worst hit since the outbreak of COVID-19. Defensive stocks (i.e. Retail, Utilities and Healthcare) are more desirable during the current crisis as they provide essential goods and services for the economy to function properly. Ideally, you should create a watchlist of fundamentally strong defensive companies that you would like to buy.

A balanced All-Weather portfolio

Great portfolios are created by fine-tuning the balance between long term financial objectives and risk tolerance levels. One such great portfolio is the All-Weather Portfolio.   All-Weather portfolio is the creation of Ray Dalio, the founder of Bridgewater Associates, one of the biggest hedge funds in the world. According to Mr Dalio, there are only four scenarios that can affect the value of your investments. They are as follows:1. Inflation – The increase in the price of goods and services or rising prices2. Deflation – The decrease in the price of goods and services or falling prices3. Rising economic growth – Flourishing economy or higher than expected economic growth4. Declining economic growth – Shrinking economy or lower than expected economic growth

Ray Dalio suggested constructing a portfolio with assets that would perform well in each of the above scenarios. The result is a diversified portfolio of Stocks, Bonds and Commodities. Performance of All-Weather portfolio in previous financial crashes:

  • Great Depression – when back-tested during the Great Depression, the all-weather portfolio was shown to have lost just 20.55% while the S&P 500 lost 64.4%.
  • In 1973 and 2002, when S&P suffered some of the worst losses, the all-weather portfolio made money.

Do not time the market but look for clues

I wish I had a magic bullet to protect your investments from market crashes. I don’t. But I want to help you protect your investments. COVID-19 has changed our perception of market volatility, but there are a few things we can look for to prepare ourselves.
Daily infection rate or growth factor of daily new cases: Growth factor is the factor by which the daily new cases number multiplies itself over time. A growth factor of 1.07 means the daily new case is growing by 7%. More than 1 indicates signs of increase, whereas less than one indicates decreasing levels. If the number stays below 1 for an extended period and continue to move towards 0, then there is a high likelihood that the market will improve. During the SARS crisis in 2003, the stock market bottomed a week after the daily infection rate topped out.

Fear Index: The current epidemic is anything like before, but there will be indications of revival. Stock market declines often coincide with VIX index spikes. Previous outbreaks of SARS in 2002-03 pushed VIX to 41. Global Financial Crash in 2008 spiked VIX to 79. As of March 24, 2020, VIX, is at 55. Before buying any stock, I would expect VIX to fall considerably. No one can predict when the market would bottom, but you can look for clues to give yourself a head start in building a better portfolio.

Key to better portfolio performance

The All-Weather Portfolio consists of 30% Stock, 40% Long Term Bonds, 15% Intermediate-Term Bonds, 7.5% Commodities and 7.5% Gold. The portfolio maximises diversification, minimises volatility and improves performance.  Higher allocation of bond in the portfolio is to balance the volatility from Stock and Commodities as bonds are negatively correlated to stocks. Timing the market is fool’s errand. Buying when the valuations are right is key to better portfolio performance.

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9

How to value companies with Benjamin Graham Formula?

How much is the company worth? Shall I buy shares now or shall I wait? If you do not know how to value the company correctly, you could make a costly mistake on your investment. Valuing a company is not an exact science Generally, the value is calculated using past...

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How much is the company worth? Shall I buy shares now or shall I wait? If you do not know how to value the company correctly, you could make a costly mistake on your investment.

Valuing a company is not an exact science

Generally, the value is calculated using past data from the balance sheet and future assumptions of the broader economy. Investors analyse a stock with a different outlook, which results in different prices. To value the company correctly, investors should give greater emphasis on previous information and rely less on their instincts.

There is no absolute value

Different valuation models explore different scenarios, resulting in different prices. Because Benjamin Graham formula looks into earnings only, it is ideal to value defensive companies. The recipe will not be useful to identify growth companies.

Therefore, if you want to find growth firms, you should use a different method.

The original Benjamin Graham Formula is incomplete

The original formula to find the value of the company was:

V = EPS x (8.5 + 2g)

where;

V= Expected value per share of the firm

EPS (Earnings per share) = the company’s last 12-month earnings per share

8.5 = P/E (Price to Earnings) ratio for a no-growth company g = long term growth rate of the company (7-10 years)

The original formula doesn’t take into account capital expenditures (i.e. money spent by businesses to maintain fixed assets and equipment). An illustration will help you understand.

Let’s assume there are two firms (Digital Media Co. and Construction Co.). They both have earnings of £1,000,000, but Digital Media Co. has a capital expenditure of £200,000 whereas Construction Co. has a capital expenditure of £800,000. Please see the comparison below:

 
  Digital Media Co. Construction Co.
Capital Expenditure £200,000 £800,000
Earnings £1,000,000 £1,000,000
Total Number of Shares 10,000 10,000
EPS (Earnings/Shares) 10 10
Growth 10% 10%

Value of Share (BG

Formula)

£106 £106

According to Benjamin Graham Formula, both companies are equally valued, making it difficult to choose the right stock. Assuming all else the same, Digital Media Co. is a better proposition than Construction Co.

The second issue with the original formula is that it ignores how much the firm is leveraged (i.e. Financed by debt). An illustration will help you understand.

Let’s assume we have two firms (Lehman Bros Co. and Microsoft Co.). They both have earnings of £5,000,000, but Lehmann Bros Co. has a total debt of £1,000,000 whereas Microsoft Co. has only £200,000 liability like below.

  Lehman Bros Co. Microsoft Co.
Total Debt £1,000,000 £200,000
Earnings £5,000,000 £5,000,000
Total Number of Shares 10,000 10,000
EPS (Earnings/Shares) £50 £50
Growth 10% 10%

Value of Share (BG

Formula)

£530 £530

Based on Benjamin Graham formula alone you will be tempted to buy the highly geared Lehman Bros.

The third issue with the original formula is that it was based on 1962 AAA corporate bond rates. To adjust the formula to today’s bond rates, we can adjust Graham’s formula to:

Where,

IV =           [EPS x (8.5 + 2g) x 4.4] / Y

V= Expected value per share of the firm

EPS (Earnings per share) = the company’s last 12-month earnings per share

8.5 = P/E (Price to Earnings) ratio for a no-growth company g = long term growth rate of the company (7-10 years)

4.4 = the average yield of AAA corporate bond in 1962 when the model has introduced Y = the current yield on AAA corporate bonds

10 Point Filter Method

To discover remarkable companies using the revised Benjamin Graham Formula, I would recommend the 10-point filter method.

The 10-point filter to find remarkable firms are:

  • Filter shares that have high-profit margins
  • Has market capitalisation more than $500 million
  • Current assets should be twice the current liabilities
  • Long-term debt should not exceed the net current assets
  • Regular dividend payments
  • The minimum increase of at least one-third in per-share earnings
  • Current share price should not be more than ten times the average earnings of the past three years
  • Current share price should not be more than 1.5 times the book value
  • Regular earnings growth yearly
  • Buying Level: the intrinsic value of the share using the revised Benjamin Graham Formula

Limitations of the revised formula:

  • Companies that have missed dividend payments recently will be not selected
  • Some reliable companies that have low-profit margins will be excluded from the final list
  • Firms that might have missed earnings growth due to the economic downturn will also be

Like any method, care should be taken on how you use them and your risk appetite. If you want to invest long term in defensive sectors, then I would recommend Benjamin Graham Formula with the 10 point filter method.

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How to identify best investment opportunities?

There is no single investment opportunity or asset class that can promise consistently high returns all the time. Many argue that real estate has always outperformed and is a good hedge against inflation. But done at the wrong time and real estate investing doesn’t...

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There is no single investment opportunity or asset class that can promise consistently high returns all the time. Many argue that real estate has always outperformed and is a good hedge against inflation. But done at the wrong time and real estate investing doesn’t work.
According to the Federal Reserve Bank of San Francisco report, The Total Risk Premium Puzzle, the annual total return of UK Real Estate averaged at 7.63% for the period from 1963 – 2015 whereas, the annual total return of UK Stocks and Shares for the same period of 8.74%.

Price and Time

There is no good or bad investment but good or bad price and time of investment.
Selecting good companies does not guarantee superior returns. See – Cable and Wireless, Xerox, British Steel, Thomas Cook, and Blockbuster. Great investment decisions are based on two things – Price paid for the stock and the time of purchase. No company is so good that it cannot be overvalued or so bad that it cannot be undervalued.

Discipline

What is most important in investing? It is not knowledge or strategy, but it is the discipline.
The riskiest thing to do is to buy something when everyone else is buying. All the information has already been factored in the price. You want to participate in an auction where there are only 2-3 bidders rather than hundreds. You want to buy something when it is not discovered. The most profitable thing to do is to buy something when no one is keen on buying it.

Be Contrarian

Your best bet is to be a contrarian investor.
There is no undervalued stock that is known by everyone. If everyone knew it, then why the price has not gone up? The bottom line is to buy when no one else will.
If everyone likes it, sell; if no one likes it, buy.

As Warren Buffet said, “the less prudence with which others conduct their affairs, the greater prudence with which we should conduct our own affairs.” When others are afraid, you needn’t be, when others are unafraid, you better be.

After Lehman’s collapse in 2008 in the great financial crash, everyone was afraid of financial stocks. The market rewarded contrarian investors who waited patiently and bought financial companies in 2009. Contrarian investors find opportunities that offer the right balance of return and risk.

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Top 10 Ways to Make Your Retirement Less Stressful

Retirement has changed quite a bit in the last few decades — instead of retiring at 65 with a life expectancy of about 10 more years, most are finding themselves retiring either much earlier or much later than 65 with a life expectancy of at least 85 (occasionally...

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Retirement has changed quite a bit in the last few decades — instead of retiring at 65 with a life expectancy of about 10 more years, most are finding themselves retiring either much earlier or much later than 65 with a life expectancy of at least 85 (occasionally even longer, in some instances). This complicates everything from longevity risk (also known as the depletion of assets before the end of life) to fewer retirement benefits to added healthcare costs and all sorts of other factors in between. Thankfully, there are ways to make sure that the stress of a transforming retirement field doesn’t get too overwhelming for modern retirees.

Make Your Retirement Plan

First and foremost, you are going to need an effective and thorough retirement plan. Still, a fairly new retirement concept, creating an income plan for your retirement fund is basically like budgeting. There simply wasn’t a need for this sort of planning before the late 2000s — up until that point, the belief was that retirees would be set for life if they invested and sold shares each month to use for their income. This just won’t do for today. Unless you have millions saved, a retirement income plan is an essential thing to have so that you can space out your money over time and not run out.

Evaluate Your Stocks          

In the past, future retirees could bank on stocks and bonds to get them through retirement with ease. Today, with the current market constantly fluctuating and future profits made on stocks and bonds expected to be significantly lower compared to decades past, the same sorts of investments that secured a comfy retirement for former generations can no longer be your safety net. Diversifying income sources by looking into alternative investments and side jobs is the new move — this kind of investment is called cash flow investing and it will be the future of retirement income plans.

Don’t Rely on Your Pensions

As with stocks, it’s not reasonable to expect to live off of pensions alone anymore. While still considered a guaranteed source of income, defined benefit pension plans from employers are on their way to being a thing of the past. They’ve seen massive cuts in recent years and are facing billions in potential underfunding, which means that retirees should consult with their financial planner to figure out backup plans into their retirement plan in case their pension ends up coming in as less than what was expected.

Increase Your Income

To maximize your retirement spending, you must first make sure you maximize your income. Thankfully, there are quite a few ways to do this: Work for at least 35 years and make sure you are always pursuing opportunities to increase your income while you’re working by pursuing side jobs. Don’t retire before you reach your full retirement age and deny retiring until at least age 70. This will ensure the most retirement income possible for you.

Back-Up Your Healthcare

Health costs aren’t getting any cheaper, which means that future retirees need to make sure they plan for the inevitable medical bills as they form their retirement plans. This may be surprising to some, but not everything is covered by the NHS. The last thing you want is to be caught up in a medical emergency that completely throws off your carefully-planned retirement budget. Things like dental care, cosmetic surgeries, eye exams, hearing aids are not always going to be covered and may have to come out of pocket. You need to set aside emergency funding just in case something unexpected arises. 

Check Your Life Insurance

In a similar vein to the precautions you need to take with your healthcare, it’s vital for you to check over your life insurance plan to ensure you’re covered in case of the worst. Likewise, it’s a good idea to check and see if your life insurance policy has accrued any monetary value that you can withdraw and use as a form of retirement income. Plus, as long as you withdraw less than your premiums, the money isn’t taxed. Only a fraction of U.K. citizens have a life insurance plan, so if you don’t have one, you should get one. 

Check Your Pensions

The main problem with pensions today is the same issue that many have faced with their stocks and bonds: the course the market has taken (and the course it’s expected to continue following down in decades to come) has transformed the concept of a pension plan from a dependable source of income in retirement to nothing more than a glorified rainy day fund. Because of this, it’s highly recommended that future retirees pay more attention to their personal savings and other cash flow investments instead. Meet with a financial advisor to determine if you need to supplement your pension plan.  

Check Your Individual Savings Account

The big difference between a pension and an Individual Savings Account (or ISA) is that the former is opened by the employer while the latter is opened by the individual. Like a pension, though, there are certain rules that restrict your contributions and keep you from enjoying the full benefits of your ISA. Consult with your financial advisor to make sure that you aren’t potentially going to be locked out of the benefits you thought you were guaranteed.

Look Into All Types of ISAs

There are five main types of ISAs: cash ISAs, Help to Buy ISAs, innovative finance ISAs, stocks & shares ISAs, and Lifetime ISAs. All can be beneficial, but not all will be one-size-fits-all. Some are for first-time buyers, some are more suited for more seasoned purchasers, and some are brand new and may be better for you than the one you currently have. Do your research and meet with a financial advisor to make sure that the ISA you’re set up with is the right one for you and suits your particular lifestyle. 

Reduce Your Living Costs 

Buying your home early and reducing your cost of living well before you hit retirement age are two of the smartest things you can do to help make your retirement go much more smoothly. Not having to cover payments for your home and learning to live well within your means will ensure maximum comfortability once you’re out of the workforce and into the life of luxury. This will leave much more money for travelling around the world, relaxing at home, and simply enjoying your retirement to the fullest, stress-free.

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DEVESH VISHWAKARMA

I have a passion for financial markets and stock research, which is why I am a fund manager. I enjoy selecting the right stocks and equities with the utmost care for my clients. Developing successful financial strategies for my firm and my clients brings me deep satisfaction.

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