MONEY stocks

WATCH: Chaos In Iraq Boosts Energy Stocks

As the chaos in Iraq continues to escalate, oil prices have skyrocketed right along with it. But in a strange twist, investors who own energy stocks are benefiting from the otherwise distressing situation.

MONEY Pick Up Speed

The One Thing You Have to Know to Invest on Your Own

You don't need pricey money managers to help you buy low and sell high.

With the 4th of July on the way, the editors here at Money.com asked me to think about what it takes to become an independent investor.

I’ll take “independent” to mean something that most people with a 401(k) or an individual retirement account can realistically do. I’m not talking about sitting at your desk all day trading your own portfolio of stocks. In fact, the way I think about independence, you’ll want to automate about 99% of the investment decisions in your portfolio — specifically, which individual stocks and bonds to hold. The independence that matters has nothing to do with security selection. It’s about cutting out costly middlemen, from advisers who help you select investments, to the managers who pick the securities inside the mutual funds you may hold.

The rewards to doing this are significant. A high-cost mutual fund may shave 1% or more off of your investments each year, which can easily add up to six figures in fees and foregone gains over a lifetime as an investor. Eliminating layers of management also means you are less exposed to the quirky risks someone else might take with your money.

You don’t need a lot of time or expertise to pick these middleman-free investments. You can build a portfolio that holds a diversified slice of stocks and bonds with just three index mutual funds, portfolios that mimic the composition of the overall market at very low cost. If stocks rise 8% in a year, you’ll earn 8% or very close to it. You very likely have index options in your 401(k) plan—if not, say something to your HR manager!—and index funds are easy to buy in an IRA.

Below is what that portfolio might look like. You can adjust the split depending on you appetite for risk, but the one below is a good starting point for many long-term investors saving for retirement. (The less you can stand to lose, the more you’d add to the bond fund.)

image(28)

In contrast to typical funds, this portfolio will cost you less than 0.1% of assets per year, and will get with three easy decisions exposure to literally thousands of stocks. You can choose index funds from our Money 50 list of recommended funds.

It’s easy to say that anyone can do this, of course. But I think a lot of people lean on investment middlemen because they aren’t sure they know enough about investing to do it themselves, and even if they want to learn, they aren’t sure which knowledge really matters. There’s so much you could dive into: stock sectors, “P/E” ratios, the January effect, EPS growth, upside earnings surprises, etc., and etc.

So here’s the one thing I think you have to understand to be a competent, on-you-own investor: Where the return on your investments really comes from. And the answer is that, for stocks, it comes from two sources. You own businesses, and you are taking a risk to do so.

Beginners are often introduced to the market with the old saying, “buy low and sell high.” This isn’t wrong (doing it the other way sure won’t feel good), but it’s not at all helpful. It makes investing sound a like a game of wits against other investors — first you figure out when a stock is too low, and then sell it when somebody else is willing to buy it for more than its worth. That’s hard, and you have to learn a lot about companies, accounting and human psychology to even attempt it. The whole edifice of the middleman money management business is built on the fact that most people believe they can’t do this themselves, or don’t want to.

But to be a buy-and-hold index investor, you can throw out “buy low/sell high” and the game-playing thinking that tends to go with it. This isn’t about finding a greater fool to buy your stock further down the road. Owning stocks gives you a claim on the earnings of companies. As an owner, you make money over time either because you are being paid a dividend out of profits, or because profits are being reinvested in the business to make it more valuable. Index funds give you a share in the future profits of the America’s, or the world’s, public companies. It’s almost as simple as that. Almost.

The other, crucial part of the equation is that the earnings of companies are uncertain and so are the cash flows shareholders will get. Stock investors get no promises that a company will ever earn enough to produce a dividend. Investors typically bake that risk into the market price of stocks, so that they can hope to be compensated with a higher return than they’d get on bonds. Historically, stocks have earned about 4.5 percentage points per year above bonds. Stock investors have on average been paid for risk — but that doesn’t mean you’ll always get paid for risk. Case in point: The nearly 50% loss investors took on blue chip stocks in the wake of the financial crisis.

If you get that, you have the baseline knowledge you need to build a diversified portfolio and stick with it. The potential for loss is built into stock investing and you only make money if you are willing to live that. The rest is (usually expensive) fiddling around the edges.

MONEY stocks

Finding the Winners in Tech’s “Bargain” Bin

Bargain basement sign in shop
Alex Segre—Alamy

Many tech companies saw their high-flying stocks lose altitude this year.

Leaders in social media like Twitter TWITTER INC. TWTR 1.2949% and LinkedIn LINKEDIN CORP. LNKD 0.1727% fell more than 40% from their 2014 highs. Others, such as the retailer Amazon.com AMAZON.COM INC. AMZN 5.5745% , took more modest drops, although shareholders might not have found them modest at the time.

These types of stocks, among others, are cheaper than they were, but are they cheap enough?

They almost certainly can’t be considered bargains by normal valuation yardsticks. The price-earnings ratios for tech companies — in cases where there are earnings — can run close to or into triple digits.

Portfolio managers are finding, however, that some businesses offer sufficient growth potential to warrant bets around current prices.

Kevin Landis, manager of the Firsthand Technology Opportunities Fund, has been adding to his position in Twitter, a longtime holding, because he expects the stock to improve over the long haul as the company evolves from an upstart held in tech portfolios into a respectable blue chip that will be far more widely owned.

“It’s only a matter of time before Twitter goes into the S&P 500,” says Landis, a Silicon Valley investor since the days of CompuServe email addresses composed of long strings of numbers. “Like Google 10 years ago or Facebook two years ago, everyone will have to own them.”

The reason that Twitter plunged in the first place, losing more than half its value, is that investors pulled back ahead of anticipated selling by corporate insiders. Many feared a massive dumping of Twitter stock once the lock-up period from the company’s November initial public offering ended. That has abated, Landis says, and the stock “really looks like it has found a bottom.”

Landis also holds Google GOOGLE INC. GOOG 1.4148% along with Facebook FACEBOOK INC. FB 2.2621% , which has nearly quadruped in value since late 2008, but he’s having reservations about the latter. Landis questions how much growth potential Facebook has left and warns that he may sell before the year is out.

“I’m still happy to hold it, but at over $160 billion [in market value], how much can it possibly make in the next 10 years?” he wonders. “I don’t know that we’ll hold it forever.”

Landis has no such misgivings about LinkedIn, a social-media company for professionals. He remained invested through the recent plunge and believes that the stock is worth buying today.

“We own it and would consider adding to it,” he says. “It’s a top brand. It’s hard to imagine a scenario where LinkedIn fades from view.” The $110 million Firsthand Technology Opportunity is up an annualized 20% in the five years through June 27, according to Lipper.

John Toohey, head of equities for USAA Investments, which offers the $571 million USAA Science & Technology Fund, has similar opinions about Facebook and LinkedIn, only reversed.

Facebook, a holding in several USAA portfolios, including Science & Technology, is the one with the greater growth potential, in his view, because its everyman customers are more tolerant of having ads thrust in their faces than the professionals who use LinkedIn.

“They have huge opportunities to monetize their base,” Toohey says about Facebook. Still, he encourages the company not to be greedy by saturating the site with ads or allowing ads that are targeted so precisely to users that it becomes obvious just how much information the company has on them.

“People are fine being marketed to,” Toohey says, “but they need to strike a delicate balance.”

Amazon.com, whose stock fell more than 25% earlier in the year, may need to execute a balancing act of its own. Amazon has spared little expense in growing its business to become a dominant retailer, but companies that spare little expense tend to have thin profit margins and generate anemic cash flow, Toohey notes. USAA Science & Technology delivered an annualized return of 21 percent in the past five years.

“We own some Amazon, but we’re cautious about it,” he says. “The challenge is whether they’ll ever slow down spending to ramp up cash flow and margins.”

Another possible impediment to Amazon and its shareholders is that it sends out so many packages at such short notice that delivery services like FedEx Corp. and United Parcel Service Inc. eventually may balk at doing the heavy lifting, at least at current prices.

“Amazon could shoot themselves in the foot,” Toohey warns. “If FedEx and UPS are going to be able to support all that volume with two days’ notice, they’ll have to hire people and do logistics. Are they going to get paid for it?”

Prospective buyers of tech high fliers may be asking themselves the same question.

Recalling the 2000 crash, Landis concedes that investors can get hurt in companies like these, but he highlights a difference between now and then – a dearth of opportunities for growth in other assets.

“After a long bull market, there’s nothing to go back to,” he says. “When people take money off the table and look around, they see that gold is played out, at least for now; there’s not much [to make] in bonds, and stocks of old-guard companies aren’t growing that fast.”

“You can go for dividend yield,” he says, “or you can go for growth.”

MONEY stocks

Iraq Crisis Fuels Short-Term Boom for Energy Stocks

Investors, though, must beware of the potential boomerang effect that almost always occurs following an energy scare.

Despite the incendiary conflict in Iraq that last week sent the benchmark price of Brent crude oil to more than $115 a barrel, U.S. stock markets largely shrugged off the oil threat.

In fact, a new energy crisis in the Middle East presents something of an opportunity for investors — albeit a fragile, short-term one.

While energy production has become much more geographically diverse, lessening the severity of a Mideast production shortfall, Iraq is still OPEC’s second-largest producer. And as is the case during any threat to global oil production, the share prices of oil companies and the funds that invest in them soar on bad news, which is what happened last week.

Owing to greater demand for oil and geopolitical tensions, ExxonMobil EXXONMOBIL CORP. XOM -0.8092% , the largest energy company by market valuation, climbed 10.5% over the three months through June 20, compared to a 5.3% gain in the S&P 500 Index S&P 500 INDEX SPX 0.1471% . BP BP PLC BP -0.3668% was up nearly 15% over the three months ended June 20.

The last three months are important because they include a spate of good reports on economic growth in Europe and the U.S. and a run-up to the political strife in the Middle East. These events, and growing demand from developing countries such as China and India, have pressured oil prices upward.

The Vanguard Energy ETF VANGUARD WORLD FDS VANGUARD ENERGY ETF VDE -0.8278% , which holds a broad portfolio of oil and gas exploration, refining and pipeline companies, gained 16% in the quarter through June 20. It holds companies like ExxonMobil, Chevron CHEVRON CORP. CVX -1.3666% and Schlumberger SCHLUMBERGER LTD. SLB -0.6066% , and nearly all its holdings are based in North America. It’s up about 16% in the three months through June 20.

For a fund that’s not dominated by the most popular energy stocks, consider the Guggenheim S&P 500 Equal Weight Energy ETF RYDEX ETF TR GUGGENHEM S&P500 EQUAL WEIG RSP 0.0261% , which holds a global portfolio of energy producers in roughly equal proportions.

The Guggenheim portfolio places more emphasis on smaller, lesser-known companies like Newfield Exploration Co. NEWFIELD EXPLORATION NFX -2.6475% , Anadarko Petroleum ANADARKO PETROLEUM CORP. APC -1.2813% and Nabors Industries NABORS INDUSTRIES LTD NBR -0.6554% . The fund is up nearly 16% for the three months through June 20. Independent companies like these may have more drilling activities in the areas where shale oil and gas are being discovered throughout North America.

Energy Shock Boomerang

Over a short period of time, it makes sense to hold energy stocks as a defense against rising oil prices. After all, companies make profits on price surges.

But on the consumer level, higher petroleum prices can act as a damaging boomerang.

When prices soar beyond a certain level, it brakes economic activity across the board. Higher fuel prices force people to drive less and stay away from stores, raise prices for everything from farm goods to plastics, and act as a tax on economic growth.

During the last draconian oil-price run-up in 2008 — when crude oil prices topped $140 a barrel — the combination of an energy shock, a banking meltdown and massive unemployment from Athens to San Francisco created a recession in Europe and North America. Towards the end of that year, energy prices bludgeoned an already-hobbled economic situation and the Vanguard Energy fund lost nearly 40% of its value, slightly more than the S&P 500 Index.

Looking ahead, what may mitigate any traumas in terms of oil prices will be growing U.S. oil and gas production, particularly in regions where “fracking” technology has liberated more hydrocarbons from shale formations from the Appalachians to North Dakota.

Production in the U.S. was up a record 1.1 million barrels per day last year, offsetting declines in global output from Libya, Nigeria and Iraq — all due to political strife.

“The huge investments seen in the U.S. have been encouraged and enabled by a favorable policy regime,” BP economist Christof Ruhl told Reuters. “And this has resulted in the U.S. delivering the world’s largest increase in oil production last year. Indeed, the U.S. increase … was one of the biggest annual oil production increases the world has ever seen.”

Across the globe, the future for energy stocks is positive long term. Consumers in China, India and Africa are buying petroleum-hungry vehicles. And until less-costly alternatives present themselves, fossil fuels will power the engines of these developing economies.

MONEY early retirement

4 Secrets of Financial Freedom

140701_HO_FinancialIndependence_1
Feng Yu—Alamy

You can shorten the path to early retirement if you start with the right strategies.

Ever since I retired at age 50, I’m often asked how I managed to reach financial security. Looking back, I see that the key factors fall into four categories—family support, career choice, money management, and personal habits and attitudes. Here’s how you can use these building blocks to reach your goals.

Start from a Strong Foundation
Some of us were fortunate to start out in families that instilled integrity, prudence, and hard work. If that’s your experience, you can be grateful. But, if not, then it’s still within your power to cultivate those qualities now. Not only will that create the conditions for your own financial success, but it will benefit everyone around you as well.

Throughout you will need patience. Typically the personal and financial decisions that will pay off in the long run require sacrificing a little today. Patience helps you live with the reality that true rewards usually require some short-term discomfort.

Choose a Career Wisely
Your choice of career is one of the most important decisions you’ll ever make. You need to love your work if you want to be great and prosper from it. So pay attention not only to your gifts, but to what makes you enthusiastic about getting up in the morning. Then, find a career path that plays to those strengths.

If you’re just starting out, and it suits you, a high-paying career in a technical or professional field will clearly advance your cause. Competence in math or technology can be a first-class ticket to building wealth. But, if that’s not possible, at least be aware of the financial implications of your college education and early career choices. A graduate in an esoteric major with five digits of student debt starts out life doubly handicapped. You can pursue your passions, integrate them with a professional track, and stay out of significant debt—but only if you make informed choices.

If you’re already in a career, look for mentors and other professional relationships that complement your skills and personality. Having been on both sides of the equation now, I can tell you that older, more experienced people generally enjoy counseling a talented and enthusiastic newcomer. It’s a relationship that pays dividends on both sides. So be open to wisdom when it’s offered. You don’t have to take every piece of advice, but it can be your starting point.

Learn to Manage Money
You might start out with a great family foundation. You might have a high-paying career that you love. But unless you live on less than you make, it won’t put you any closer to financial freedom. In fact, if you develop expensive tastes in houses and cars, and need to look as affluent as your neighbor, you could wind up worse off financially—no matter how much you make. You can start heading in the right direction by simply tracking your expenses, as well as learning about saving and budgeting. Identify the few areas where money spent truly pays off in better quality of life for your core interests. Spend there, and cut back everywhere else.

Next, find a mentor to help you become a confident investor. You need to master any fear of stocks, so you can profit from them in the long run. Offset the risk of stocks by allocating into other asset classes as well. Start small and carefully, but do start. Learn and abide by a few bedrock investing principles: diversification, patience, simplicity, low expenses. Track your net worth and your overall portfolio return each year, so you know what direction you’re going, and why.

Related: Find the right mix of stocks and bonds

Once your career and finances are on track, you can explore more entrepreneurial paths for wealth building—perhaps by owning a small business or real estate. These can leverage your time and money, getting you to financial independence years earlier. They can be fun and rewarding too!

Keep Your Perspective
Even with all these potent ingredients for success, be sure to take life one day at a time. Again, cultivate patience. You’ll need it for the long stretches.

Remember the goal—financial independence —but don’t obsess on it. Don’t sacrifice the present for the future; it won’t turn out as planned anyway. Make time for your loved ones and meaningful activities, even if you must work longer in the end. As great as it is to achieve financial freedom and retire early, you don’t want to arrive there having missed out on life along the way.

Darrow Kirkpatrick is a software engineer and author who lived frugally, invested successfully, and retired in 2011 at age 50. He writes regularly about saving, investing and retiring on his blog CanIRetireYet.com. This column appears monthly.

MONEY Hit Peak Performance

Don’t Be Fooled by the “Everything is Awesome” Market

Thumbs up
Walker and Walker—Getty Images

All kinds of investments are making money so far this year. What's the deal with that?

It’s the Everything is Awesome! market.

The Wall Street Journal has a neat graphic showing that for the first half of 2014, it looks like every major kind of financial asset went up: U.S. stocks, foreign stocks, gold, bonds, commodities… The paper reports that this is the first time in 20 years all these indexes have moved up together.

So what’s up with all this up?

Ironically, it may be a result of how sluggish the recovery has been. The economy is indeed improving, in large part because not so long ago it could hardly have been much worse. Sometimes when the economy looks strong and stocks are booming, bond investors get worried as they anticipate the Federal Reserve raising interest rates to hold back inflation. (Bonds fall in value when rates rise.) But Fed chair Janet Yellen has been signalling that she still sees plenty of slack in the economy, especially in employment figures, and that the current policy of rock-bottom rates is going to stay in place for a while longer. So that’s kept bond markets bullish in step with stocks.

The fact that both bonds and stocks are up this year may also be a coincidence stemming from the fact that, as the Journal notes, fixed-income investors over-corrected in 2013. When then-Fed chair Ben Bernanke began tapering “quantitative easing,” markets saw it as a sign that the era of easy Fed policy was coming to an end sooner than expected, and bonds tanked. Values have climbed back since as it’s become clear that the Fed may have jumped the gun.

At this point, if you have any contrarian impulses, your Spidey sense is probably tingling. If markets are climbing everywhere, and the mass of investors see only blue skies ahead, that’s got to signal impending doom, right? That’s not a bad mental reflex, but it can get you into trouble if it leads you to try to time the market’s turns, which most investors are terrible at. Here’s what I think is a rational way to adjust to an optimist’s market:

DO adjust your return expectations.

By many measures, assets look relatively expensive now, and that means they are priced to deliver smaller gains. This is pretty obvious when it comes to bonds, because when they go up in value their yields go down. Right now, a 10-year Treasury is yielding just 2.5%, and that’s as good a guide as any to what you can expect to earn on bonds in the coming decade.

The same logic holds true for stocks. With the caveat that stock returns are never as predictable as bond returns, higher stock prices relative to earnings means you should expect to earn less on them in the future. And stocks are richly valued now, as I explain here.

If you have long-run expectations for lower returns, you might not change anything about your portfolio. But you would make your planning assumptions more conservative. That means saving more if you can, or spending less of your savings.

DON’T try to get too fancy.

When the outlook for future returns is low, investors often start “reaching for yield,” investing in new kinds of assets which seem to offer better returns. That often means taking on new kinds of risk, too. The trouble is, these risks often aren’t apparent to investors. Since new mutual funds designed to take advantage of investors’ hunger for yield haven’t been around for very long, you can’t always see in their records what happens to them in bear markets.

Eric Jacobson, senior bond fund analyst at Morningstar, tells me he’s been keeping an eye on the growing group of “unconstrained” or nontraditional bonds funds. These funds use a variety of strategies to try to outdo today’s low-yielding government and high-quality corporate bonds. For example, they may stretch into lower-rated or junk bonds. There’s nothing inherently wrong with such a strategy. But Jacobson does wonder if all the investors who have poured money into these funds know what they are bargaining for. “There may be more credit risk and market risk than people understand,” he says.

When everything is up, new strategies look great. Corrections tend to bring investors back to plain vanilla.

MONEY stocks

These 5 Tweets Explain Why Twitter Stock Isn’t About to Rebound

Twitter logo on iPhone
Scott Eells—Bloomberg/Getty Images

The social media stock is quickly maturing before our eyes. And that's not music to investors' ears.

It’s no secret that Twitter shares TWITTER INC. TWTR 1.2949% have had a rough few months, marked by a wave of analyst downgrades, insider selling following the end of the stock’s lock-up period, and now signs of slowing growth.

The real question is: Which of the charts below represents the market’s true take on the stock?

This one, which shows how Twitter shares cratered from late December to late May?

TWTR Chart

TWTR data by YCharts

Or this one, which shows how the stock has rebounded from its late May lows?

TWTR Chart

TWTR data by YCharts

The Twitter bulls argue it’s the latter. But here are five reasons — articulated on Twitter by my MONEY colleague Taylor Tepper — that I’m not inclined to believe them:

1)

Sure, that was bound to happen as the social media platform gained in size. There are already 255 million Twitter users worldwide.

However, the fact that the company’s rate of growth is slowing so noticeably — it is expected to fall from an annual pace of 24% this year to 15% two years from now and then to less than 11% in 2018, according to a study by eMarketer — is becoming worrisome.

“We can’t deny that growth in users has been slowing,” says Morningstar analyst Rick Summer, which is a critical point given that “the company is competing for advertising dollars with juggernauts such as Facebook and Google.”

2)

For most companies, the fact that the lion’s share of growth is coming from rapidly developing Asia — and specifically China — would be viewed as a bullish sign. In the case of Twitter, though, which generates nearly 90% of its overall revenues from ad sales, this isn’t necessarily good news for near-term profitability.

Remember that in online ads, the big money is still made in the developed world. Yet in Twitter’s case, the percentage of the company’s users that are in North America and Western Europe is expected to slip to only one third by 2018, down from nearly half in 2012, according to eMarketer.

3)

Twitter officials often point to how much advertising revenue the company is generating per thousand “timeline views,” which is sort of like Twitter’s version of a web page view. In its most recent quarter, the company touted that “advertising revenue per thousand timeline views reached $1.44 in the first quarter of 2014, an increase of 96% year-over-year.” That’s true.

But they played down the fact that the overall number of timeline views for the quarter — 157 billion — was actually below the peak of 159 billion achieved last year. This, despite the fact that the overall user base continues to grow.

4)

Social media is all about buzz. Advertising, which most social media companies need if they hope to turn a profit, is all about scale. And right now, Twitter’s user base pales in comparison to that of Facebook, with its 1.3 billion users. In fact, Google+ and LinkedIn, with their 300-million-plus users, are even bigger than Twitter.

5)

About a year and a half before Twitter went public, Facebook made news by buying the mobile photo sharing app Instagram for $1 billion. Seems like chump change compared to the $24 billion that the stock market says that Twitter is worth, based on its current market capitalization.

Yet Facebook CEO Mark Zuckerberg recently provided numbers showing that Instagram is closing in on Twitter, with more than 200 million monthly active users worldwide.

More importantly for mobile ads, more Americans are using Instagram on their smartphones than are using Twitter — by eMarketer’s count, 40.5 million for Instagram versus 37.3 million for Twitter. And by many accounts, Instagram is now a key engine in Facebook’s ad strategy, particularly in China.

Which begs the question: Which price is more accurate — the $1 billion that Zuckerberg paid for Instagram, or the $24 billion that the market says Twitter is actually worth?

MONEY stocks

How Nike Scored on Adidas at the World Cup

140626_INV_NIKEAHEAD
Jeff Golden—Getty Images

Just as the U.S. World Cup team's 1-0 loss to Germany turned out to be a win, Nike tying Adidas in soccer sales represents a big victory.

It’s widely known that Nike is furiously trying to chase down German-based Adidas on the soccer pitch — pretty much the only arena in which the Beaverton, Oregon company doesn’t dominate its European rival.

New numbers released Thursday show that Nike, through strategic marketing surrounding the World Cup this year, may have just scored the equalizer.

In announcing its quarterly results, Nike reported that for the fiscal year ended May 31, the company’s overall soccer-related sales grew to $2.4 billion. That represents an 18% jump from last year. And if you adjust for currency fluctuations, it represents a 21% increase from the fiscal year ended May 2013.

Despite headwinds from foreign exchange, Nike “appears to be able to keep momentum going,” says Morningstar analyst Paul Swinand.

Not only do these numbers mean that soccer is now nearly as important as basketball for Nike. It also puts Nike in a virtual tie in this key category with Adidas, which earlier this week said it’s on track to achieve its goal of generating 2 billion euros in soccer-related revenue, which at current exchange rates works out to around $2.7 billion.

Keep in mind that Adidas is an official FIFA World Cup sponsor, a distinction for which it reportedly spent around $70 million. Nine national teams in Brazil are competing in the company’s gear and apparel.

By contrast, Nike has gone for a more targeted approach. The company has launched a successful “Risk Everything” ad campaign which is making headway on social media. The company has also gone after the biggest individual celebrities, rather than institutions. Of the top 10 global soccer stars, as measured by their marketing/celebrity wattage, six are wearing Nike gear, including Brazil’s star striker Neymar Jr.

Even as the underdog, though, the company scored big, especially on Wall Street. Over the past year, Nike shares have trounced those of Adidas.

NKE Chart

NKE data by YCharts

And in business, that’s really the only scoreboard that counts.

MONEY The Economy

New Inflation Data Puts Janet Yellen’s Fed—and Investors—in a Bind

Janet Yellen
U.S. Federal Reserve Chair Janet Yellen. Jonathan Ernst—Reuters

Thanks to the Federal Reserve's attempts to be more "transparent," it must now balance the battle against inflation with its fight for jobs—all out in public. Maybe it's time to run silent.

There’s a reason people tell white lies. Being completely open and honest all the time quickly lands you in awkward situations. And that’s where Federal Reserve chair Janet Yellen finds herself today.

This morning, a key gauge known as the price index for personal consumption expenditures (or PCE) showed that inflation is now rising at an annual rate of 1.8%. That represents a noticeable jump from earlier this year.

US PCE Inflation Rate Chart

US PCE Inflation Rate data by YCharts

Not only that, the PCE price index confirms what the more widely followed consumer price index has already been telling us: That inflation, though mild by historical standards, is now rising at around a 2% clip.

US PCE Inflation Rate Chart

US PCE Inflation Rate data by YCharts

Why is this important? Because in an effort to be “transparent” a couple years ago, the Federal Reserve, then led by Ben Bernanke and vice chair Yellen, began telegraphing to the investment world what rate of inflation it is shooting for.

In fact, Fed officials literally stated that they are shooting for the PCE price index to rise at an annual rate of 2%. Here’s what they said in their 2012 press release:

The inflation rate over the longer run is primarily determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for inflation. The Committee judges that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve’s statutory mandate. Communicating this inflation goal clearly to the public helps keep longer-term inflation expectations firmly anchored, thereby fostering price stability and moderate long-term interest rates and enhancing the Committee’s ability to promote maximum employment in the face of significant economic disturbances.

In essence, the Fed wants investors to know exactly what to expect in terms of the central bank’s policies in setting short-term interest rates. That way, the market won’t misinterpret the Fed and overreact when it comes to establishing long-term interest rates.

But for this relationship to work, Yellen will have to follow through on the Fed’s promise. The markets will demand that the Fed address the potential threat of inflation once it crosses 2%, and the data released on Thursday clearly show that we are nearing that point.

Folks are already beginning to call for the Fed to do just that. As Howard Gold at Marketwatch noted, “amid clear signs the economy is recovering, Yellen and the Fed face a different challenge,” he wrote. “While continuing to fret over the ‘weakness’ of the labor market and even encouraging some short-term inflation, they will have to keep underlying inflation from getting out of hand.”

Yet if the Fed addresses inflation too abruptly — or in the opinion of investors too aggressively — by ending stimulus and actually lifting short-term rates, the market’s bulls may use that as a sign to take the summer off.

Times like this are when Yellen probably wishes she had the flexibility to act in private as many of her predecessors had.

It’s often forgotten that when Alan Greenspan began his chairmanship in the late 1980s, the Fed did not even tell Wall Street that it had changed interest rate policy. The only way the public found out was to see how bank lending rates reacted after the fact.

Today, the Fed not only issues press releases, Yellen herself gives lengthy press conferences, as Bernanke did.

But here’s a novel idea: Why doesn’t the Fed simply pipe down about what it thinks it’s likely to do going forward, and just do what it thinks is right? Quietly.

If investors learn after the fact that rates had been rising all along — alongside equity prices — perhaps investors will realize that they don’t need such a stimulative Fed to keep stocks going higher.

TIME

Stocks Head Lower on Wall Street, Led by Banks

NEW YORK — The stock market sank Thursday following a disappointing report on Americans’ spending last month. Bed Bath & Beyond and banks were among the biggest losers.

KEEPING SCORE: The Dow Jones industrial average fell 79 points, or 0.5 percent, at 16,787 as of 12:30 a.m. Eastern time. The Standard & Poor’s 500 index sank nine points, or 0.4 percent, to 1,951, while the Nasdaq composite index fell 18 points, or 0.4 percent, to 4,362.

ECONOMY: The government said the number of Americans seeking unemployment benefits declined last week, the latest evidence that an economic slowdown earlier this year hasn’t caused employers to shed workers. In a separate report, the government said consumer spending inched up 0.2 percent last month, half the increase that economists had predicted.

RESPONSE: “The spending data was a soft, but it’s not that big of a deal,” said Phil Orlando, chief equity strategist at Federated Investors.

Orlando said the stock market has been rising a little too fast recently, so a slight drop in the summer months wouldn’t come as a surprise. “I fully expect to see a hiccup here, but I wouldn’t get too worried about it,” he said. “It’s probably going to set us up for a nice end-of-the-year rally.”

TRADING SCRUTINY: Barclays fell after New York’s attorney general sued the British bank, claiming that it favored high-frequency traders over large institutions in its private-trading platform, known as a “dark pool.” Eric Schneiderman accused Barclays of misleading investors by saying they were safe from predatory high-frequency traders. Barclays’ U.S.-listed shares fell 97 cents, or 6 percent, to $14.74.

Other banks that operate similar private-trading platforms also dropped. Morgan Stanley sank 64 cents, or 2 percent, to $69.75. Citigroup slipped 63 cents, or 1 percent, to $47.20.

TOOK A BATH: Bed Bath & Beyond sank 9 percent, the biggest loss in the S&P 500, after the company posted quarterly earnings and sales late Wednesday that fell short of analysts’ estimates. The store’s stock dropped $5.26 to $55.85.

POPPED: GoPro jumped 32 percent in its stock-market debut. The company, whose cameras get strapped to the heads of skydivers, extreme skiers and surfers, raised $427 million in its initial public offering Thursday. GoPro soared $7.15 to $31.17 in its first day of trading on the Nasdaq stock market.

HEAVY METAL: Alcoa plans to acquire Firth Rixson, a British maker of jet-engine parts, for $2.9 billion, as the company continues to shift away from its aluminum-smelting roots. Alcoa’s stock rose 31 cents, or 2 percent, to $14.86.

EUROPE: Major European markets mostly fell. France’s CAC 40 fell 0.5 percent while Germany’s DAX lost 0.6 percent. The FTSE 100 index of leading British companies was flat.

BONDS AND COMMODITIES: In the market for government bonds, the yield on the 10-year Treasury note dropped to 2.52 percent from 2.56 percent late Wednesday. Bond yields fall when prices rise. The price of crude oil fell 43 cents to $106.07 a barrel.

Your browser, Internet Explorer 8 or below, is out of date. It has known security flaws and may not display all features of this and other websites.

Learn how to update your browser