Despite the headlines about an impending recession and wobbles in the stock market, it’s still a great time to be an equity investor.
Both Schwab and TD Ameritrade announced yesterday that they would be offering zero commission trades on stock and ETF trades. Schwab also announced that options contracts will now be $0.65 per contract (one contract covers 100 shares). They join commission free online brokers like Robinhood and Webull which already offer commission free stock and ETF purchases as well as low priced options contracts. Schwab alone is expected to lose $300 million on this strategy since they were previously charging $6.95 per trade.
It’s all part of a general race to the bottom that many attribute to Robinhood but actually started when online trading began to cut into broker commissions in the late 90’s. I saw the trend coming when brokerages big and small started to offer blocks of free trades when you either have a minimum balance or signed up for a new account about 10 years ago. I personally was able to track down a since discontinued deal with Wells Fargo where if you held $25,000 or more in a checking, savings or brokerage account, you would get 100 free trades a year. Since I am a buy and hold investor, this was more than enough for me to no longer pay commissions.
In posts like It Has Never Been Easier to Invest and Get Rich, I discussed how we should take a step back and have an appreciation for the fact that the average joe in the US can send an investment with the click of a button to the far reaches of the earth. This could be through buying ADRs (foreign companies listed on the NYSE) of say, Swiss food maker Nestle, or shares of Alibaba Group in China. With the aggregation of fixed income securities through bond mutual funds and bond ETFs, you can also spread your money over a broad array of fixed income investments of which the portfolio may include everything from derivatives, to short term commercial paper to African sovereign bonds or European corporate bonds.
Money is moving around the globe at a pace faster than ever, which is why it’s so perplexing to me why people aren’t doing the two basic things they would have to do to greatly improve their financial situation: saving money and investing that money.
The announcement today of the zero commission trades offered by TD and Schwab show that the barriers to entry continue to fall not just for trades but in terms of knowledge and know how. There are more than enough free online courses that can teach you how to discipline yourself to save and teach you how to invest after you have saved something. It’s literally all at your fingertips if you have a smart phone and are willing to do the research.
But Stocks Are Overvalued Right?
If there is one thing I have learned after many decades of investing, it’s that you need to turn off the TV and stop following the day to day movements of the market. The most successful strategies are the most boring ones: dollar cost averaging by putting a fixed amount or a certain percentage of your salary into the market each month and not buying and selling too often. This smooths our the ups and downs of the market in terms of your return and has shown to beat those who try to time the top and bottom of the market.
So that is one reason I continue to plow money in the same way I always have into my 401k and my son’s 529 college plan. The key to understanding why most people need to keep plugging away at the equity market is because bonds really just aren’t giving savers much return anymore.
The capitalization of all the stocks in the world (i.e. their total value) is about $85 trillion and the total amount of global debt outstanding including sovereign and corporate issuers is about $100 trillion. Of that $100 trillion, $12 trillion now have negative nominal yields. When you talk about the yields of all bonds net of inflation, bonds with negative yields total $25 trillion, or a quarter of all the bonds out there.
With that said, if you have a choice for the next 20 years to invest in a guaranteed loss bond or to take your chances with the equity market, you are almost always going to go with the equity market.
To demonstrate this, in a recent Forbes article showed the equity risk premium today versus its long term average over the last 20 years. The equity risk premium is calculated as the earnings yield of stocks (earnings per share divided by the stock price) versus the yield you get on the safest bonds. In the example below, the author compared the equity index, the MSCI All Country World index yield, which captures a majority of the world’s shares, with the yield of the Barclays Global Aggregate Bond Index which includes investment grade sovereign and corporate bonds from 24 countries.
Source: Forbes
This also goes to show that this isn’t just an EU or US phenomenon but rather a worldwide secular decline in interest rates that we may have to deal with for some time to come. This decline will naturally push investors more towards stocks just to achieve a decent return over the long term.
Why Is There So Much Negative Yielding Debt Anyway?
Besides the obvious fact that certain central banks have been implementing negative rates for years which you can see below, we have to look deeper and understand what would motivate someone or an institution to purchase negative yielding securities.
Source: Bloomberg
Many insurers, asset managers and pension providers have to park money long term and they need the safety and liquidity that government bonds offer. It’s not as simple for them as you and I who can just go and put our money in the bank with a government guarantee that we will get our money back. Large institutions have few options when it comes to safe havens: there are restrictions since the crisis worldwide on placing it with banks and even banks can’t park all of their “safety money” at the central bank. This means that pushes many institutions and banks to just park it in a negative yielding bond with the comfort that you can sell it for near face value if you ever need to, even if you have to take a small loss.
There is also the option for these investors of swapping their negative yielding bonds for positive yielding ones like US Treasuries. I like the example of a Japanese pension fund manager. His incoming pension funds which he has to invest are in yen and he has some immediate payouts and some money he has to save for future pensioners so he naturally has to park some money in Japanese government bonds which have a negative yield. Once he does this he will still receive some interest and that will be in yen. He can enter into a cross currency rate swap to trade his yen interest for US dollar interest linked to treasuries with a big investment bank. The reality is though, that there is pricing embedded within such a swap called the basis cost. This cost usually makes the overall swap cost is so high that it ends up making the return for the Japanese pension fund manager negative in US$ as well so he just decides to park his money in Japanese bonds and eat the loss.
To top it off, now corporations, realizing they can issue debt which is essentially free, they are using much of the proceeds to buy back their own stock. This in turn reduces the number of shares outstanding even if the overall earnings of the company are the same. So on a per share basis, it just looks like earnings are going up. This is why stock buybacks have become more popular than dividends in the US. Take look at stock buybacks versus the level of the S&P 500 since the late 80’s and you get an idea of how this plays out over the long term.
Source: CNBC and The Visual Capitalist
In addition, this boosts the earnings yield on the market overall and just continues the cycle of why people need to stay in stocks.
What It Means for Stocks and Your Savings
What it means is that given the negative debt and the buybacks, even with some volatility, everyone saving for retirement or just investing for the long term is pretty much locked in to equities and equity exposure. With the equity risk premium still above its trend, equity investing is here to stay, no matter how we feel about it. I have heard rumblings, like we do every downturn, that you should be in gold, that you should be in crypto or some other latest and greatest investment. Keep in mind that these are part and parcel of the same things: trying to time the equity market, which is a pointless exercise.
More important than trying to find the hottest investment is to organize your funds and segregate them based on your future needs: cash for those needs in the next 3-6 months, short term money markets, CDs for 6months to 2 years, bonds for 2-5 years and then a mix of bonds and equity after that. Dollar cost averaging any additional money into long term savings will yield spectacular results over the long term with this segregation and discipline, you just need to keep your eye on the end goal.
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