Ted Bauman

  Editor, The Bauman Letter  

[tedbaumanguru-blog]

Act Now on Tax Reform and Save Thousands

Originally published at: https://banyanhill.com/income-tax/

I have a friend who’s a tax attorney. He loves to chat. Whether by phone, email, Skype or smoke signals, he’s usually good for three to four calls a week.

I haven’t heard from him since late November.

I called his office in the first week of January to see how he was. His secretary said he was at a tax planning conference.

I tried again last week. Same thing. Another meeting of tax lawyers.

I finally texted him that I had a lead on an urgent tax opinion request. That got me a return call.

The opinion request was mine. He’s on the case.

You see, since the beginning of this year, it seems like all I’ve done is study the Tax Cuts and Jobs Act, the new law governing our tax code.

There’s a good reason for my urgency … you’re losing money every day of 2018 that goes by that you don’t find out about and act on the new opportunities and threats on the tax front.

If you act now, you stand to save potentially thousands of dollars in federal tax this year. The sooner you act, the more you’ll save.

Here are the top things to watch out for … all of which will be covered in detailed how-to editions of The Bauman Letter in the coming months.

Tax Savings for Pass-Through Entities

Pass-throughs are business entities that pay no tax … they “pass-through” their profit or loss to their owners for tax purposes. They include traditional Bauman Letter topics such as limited liability companies (LLCs), partnerships and S corporations.

Starting on January 1, many owners of pass-throughs will pay no federal income tax on 20% of the profit from their businesses. That’s right, zip, nada. For many people, this could mean a big drop in their effective federal income tax rate.

The rules for this giveaway to pass-through owners are straightforward for people whose taxable income is well into the low six figures. After that, they get more complicated.

No matter how you slice it, however, the new tax law creates opportunities for huge tax savings.

Action item: If you’re a lawyer, doctor or other professional in private practice, seek tax advice immediately to see how splitting your business into parts could save tens of thousands on your tax bill.

Action item: If you’re self-employed or operate through an LLC or small partnership, cut your personal salary to the bone immediately. That increases your business’s “profit” … the amount from which you can deduct 20% tax free.

Action item: Even if you’re employed, consult a tax attorney to see if you’d be better off becoming a consultant. For many, many people, the answer is going to be yes.

Bonus tip: Owners of shares in real estate investment trusts (REITs) or publicly traded partnerships (PTPs) pay no tax on 20% of their qualified REIT dividends and PTP income.

Elimination of Key Deductions

The professed goal of the tax bill passed in late December was to reduce tax rates and simplify the tax code. The first was partially achieved — until cuts expire in 2025, at least – but the second didn’t happen. Instead, legislators included a few scattershot attempts at “simplification” that could cost you dearly if you don’t prepare for them.

First, when the press began to refer to the “elimination of SALT” late last year, I thought the Trump administration was going to abandon the Cold War-era nuclear arms treaties between the U.S. and Russia. The truth was better, but for many of us, not by much.

Starting this year, you can only deduct a maximum of $10,000 of state and local income and property taxes (SALT) from your federal taxes. For most people that won’t matter because the standard deduction for joint filers has been doubled to $24,000. But for many people —and not just in high-tax states like New York and California — this will mean an effective increase in federal tax.

Legislators in an increasing number of states are considering ways to get around this, however. You know those inside sections of your local newspaper that cover state legislative issues? Time to start reading them.

Second, the new law eliminates all “miscellaneous” deductions … including those for home office expenses. If you’re an employee who works remotely at your employer’s request, or if you run a small business from home, kiss the deduction for business use of your home bye-bye. In my case, for example, that’s a significant tax increase.

Action item: Find out if your state legislators and city councilors are considering steps to convert income and property taxes into forms that could be deducted from federal income tax. Let ‘em know what you think!

Action item: If you work from home, model the tax implications of the loss of the home business-used deduction. You may able to rearrange things to compensate, at least partially.

Bonus tip: Deductions for unreimbursed job expenses, job-search costs, tax preparation fees, home appraisal fees, casualty and theft losses, gambling losses, many investment fees and expenses and losses on IRAs may have been eliminated, depending on upcoming IRS rulings.

Get Ready to Cut Taxes on Your Retirement Income

If you’re not yet retired, and earning the right amount of annual income, I have three action items for you:

If you don’t have one already, open a Roth IRA.

Create a C corporation with your Roth IRA as sole shareholder.

Look out for the March edition of The Bauman Letter for a remarkable hack that can cut our overall taxes on your retirement earnings by as much as 50%.

Ringing off the Hook

My tax lawyer friend apologized profusely when I finally got hold of him. His phone, he said, was “ringing off the hook.”

“So is The Bauman Letter inbox, pal,” I said. “We gotta get busy.”

So must you.

Kind regards,

Ted Bauman

Editor, The Bauman Letter

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[tedbaumanguru-blog]

The Incredibly Easy Way to Boost Your Gains by 1,900%

About a month ago I spotted a little-known opportunity for profit.

The play involved an outfit that had been mismanaged for years, but still had a lot of underlying value. They were due to choose new leadership in mid-December. The outgoing board had their slate; the reformers had theirs. I gambled that shareholders would go with the reformers, and markets would reward the outfit’s price accordingly.

I chose correctly, and I’ve gained almost 13% in just three weeks. By contrast, the S&P 500 is only up a little over 2.5% in the same period.

That prompted me to go back and look for similar plays over the last year. There were plenty of them. But very few people benefited from them.

On average, over the last 12 months, making these sorts of investments would have earned you a whopping 70% more than the S&P 500 … and I’m convinced they’re going to repeat that performance in 2018.

Hidden Profits in Emerging Markets

The “stock” I bought in mid-December was the iShares MSCI South Africa ETF (NYSE: EZA).

My other home country has been badly misruled for a decade, but as I expected, the ruling party chose a solid reformer as the next president. Markets reacted accordingly, and I scored … but only because I pay attention to this particular emerging market and got in early.

You should be doing the same in 2018. I predict that emerging markets (EMs) are going to be one of the big winners of the year.

In 2017, EMs were a bit of a sleeper hit. The S&P 500 was up just over 20% last year. Everybody was chasing U.S. equity gains.

But EMs soared over 37% in 2017.

The chart below compares two common EM exchange-traded funds (ETFs), the iShares Core MSCI Emerging Markets ETF (NYSE: IEMG) and the Vanguard FTSE Emerging Markets ETF (NYSE: VWO), to the SPDR S&P 500 ETF (NYSE: SPY).

EMs are poised to do the same … or better … in 2018.

Why?

Part of the story is that the U.S. dollar in 2017 posted its worst annual performance in 14 years. That boosted foreign-denominated EM stocks in dollar terms. Indeed, there’s an inverse relationship between EM valuations and the dollar.

The one-year performance of the dollar-tracking PowerShares DB U.S. Dollar Index Bullish ETF (NYSE: UUP) shows why the U.S. currency has helped emerging markets:

A Classic Value Play

It wasn’t all just about the dollar.

2017’s EM performance was based primarily on strong corporate earnings growth. There’s no reason for that to stop. In fact, the consensus estimate is that EM companies are expected to deliver over 13% earnings growth in 2018.

There are plenty of reasons to expect that to translate into stock price growth in 2018, and by extension, growth in EM ETFs like VWO, IEMG and the iShares MSCI Emerging Markets ETF (NYSE: EEM).

First, even after a strong 2017, EM stocks are trading at only 12.5 times estimated 12-month earnings. That’s more than a 25% discount compared to developed country stocks. Moreover, EM stocks only traded at just under 12 times estimated 12-month earnings at the start of 2017 … so there’s plenty of room for continued growth in valuations.

Second, EM equity cycles tend to last several years. Between 2002 and 2007, for example, EM ETFs returned an annualized 29% a year — for five years. 2017 was Year One of a new cycle like that.

Third, although much of 2017’s EM performance was due to a rebounding Chinese market, other regions are poised to join in. India is looking good, and Brazil and South Africa are coming off extended periods of weakness and are significantly underbought.

In other words, like my South African ETF, EMs are classic value plays right now.

Time to Rotate Offshore Stocks

It’s great that U.S. stock markets are at all-time highs.

But it’s a lot greater for people who bought into them a year or so ago. It’s highly unlikely that we’ll see another year of 20%-plus gains. Even if we’re not at the top yet, the rate of climb is slowing. It must.

Most institutional analysts see 10% to 12% growth in overall U.S. index valuations this year.

But it’s entirely likely that we will see another year of stratospheric gains in EM equities and ETFs. Last year, they beat the U.S. market by 70%.

If I’m right about EMs … and if the big banks and financial analysts are right about U.S. markets … investing in EMs this year could produce excess returns of 200% over the S&P 500!

You might have missed the start of the Great U.S. Bull Run, but there’s no reason for you to miss the next one — offshore.

Kind regards,

Ted Bauman

Editor, The Bauman Letter

[tedbaumanguru-blog]

12 Insanely Profitable Tax Moves To Make Now

Most people know the 1967 World War II film The Dirty Dozen … at least by name. It’s become shorthand for any set of 12 things that can be advantageous to do, even if they seem a bit disreputable.

The IRS, for example, publishes a Dirty Dozen list of tax scams every year. It includes both scams perpetrated against taxpayers, and those perpetrated by taxpayers against the IRS.

For my final Sovereign Investor Daily article of 2017, here’s my Dirty Dozen list of tax steps you can undertake before December 31 to wring the maximum amount away from Uncle Sam before the law changes in 2018.

Every one of them is a direct consequence of the Republican Party’s looming federal income tax changes. And every one of them is perfectly legal.

Good Federal Income Tax News … and Not So Good News

Let’s start with a review of the structure of the new federal income tax system — good and bad.

On the plus side, as of Friday last week, the GOP tax plan included lower marginal tax rates for all income brackets, at least until 2027.

All else being equal, that will reduce most people’s taxes at first:

In addition, owners of pass-through businesses such as limited liability companies (LLCs), partnerships and S corporations will now be able to deduct 20% of their profits from their personal income taxes, up from 17% at present.

For example, if your LLC earns $100,000 in profits, $20,000 of that will be tax-free. The remaining $80,000, plus whatever you draw in salary for yourself, will be taxed at the rates above.

The increase in the standard deduction will result in far fewer households itemizing their deductions. Currently about 30% of households do; under the GOP plan only 5% would do so, since the standard deduction would be higher. Many lower-income households will benefit from the higher standard deduction.

Make Hay While the Sun Shines

That’s the good stuff. But for many of us, the news isn’t all good.

Above all, the combination of the elimination of the personal exemption, a cap of $10,000 on deductions for state, local and property (SALT) taxes, and a limit on mortgage interest deductions will mean that many households — especially in high-tax states — will end up paying more tax.

Nevertheless, this creates simple tax moves that you can undertake between now and the end of the year. They are all based on the principle that if you maximize your itemized deductibles now, lowering your 2017 federal income tax bill, you’ll come out ahead … because you won’t be able to deduct them in 2018.

If you anticipate that your itemized deductions in 2018 will be less than $24,000, you won’t benefit from itemizing.

But if you prepay some of 2018’s deductible expenses now — adding them to your 2017 itemized deductions and reducing your federal income taxes this year — you’ll be able to benefit from them one last time. For example:

1. Give more to charity before December 31. (Note that if you’re thinking about donating stocks to charity, and you own different lots of the same company’s stock, donate the most valuable lots this year. Under current law, you can donate the shares that have appreciated the most to get the largest charitable deduction. Under the new law, you will have to sell the shares first in, first out.

2.  Prepay your 2018 property taxes in full. (Under the final version of the tax bill, you are unfortunately not allowed to prepay 2018 state and local income taxes, but property taxes are fair game.)

3. Prepay next year’s mortgage interest.

4. Prepay any outstanding student loans.

5. Prepay medical expenses that you know you will incur next year, such as a scheduled procedure.

6. If you live in a state that charges sales tax on automobile purchases up front, buy a car before the end of 2017 so you can add that tax to your 2017 itemized deductions.

The same logic also works in reverse. For example:

7. Since you’ll face a $10,000 cap on SALT tax deductions next year, if you live in a high-tax state like New York or California, try to move some future earnings into 2017, boosting your SALT taxes — and thus your itemized deduction — for 2017.

8. Similarly, if you expect to get an annual bonus early next year, ask for it to be prepaid in December.

9. If you’re a consultant or on retainer, see if you can get clients to prepay some of next year’s invoices now to boost your 2017 earnings.

There are also some more arcane strategies you can adopt:

10. If you’re planning to undertake a 1031 swap in 2018 for something other than real estate — say, business equipment or artwork — do it now. From 2018, 1031 swaps will be limited to real estate only.

11. If you’re thinking of converting a traditional IRA into a Roth IRA, run the numbers to see if you will be better off doing it before the end of 2017 to increase your taxable income, which you can offset with some of the itemized deduction strategies above. (Bear in mind that you can do a Roth conversion even if your income exceeds the cap for Roth contributions.)

12. For the pièce de résistance, consider converting yourself into a limited liability company. Depending on your income level, you could double your tax savings by quitting your job today and returning tomorrow as a paid consultant.

Remember, these are all perfectly legal.

But I’d go ahead and look for an experienced tax attorney anyway … after all, with the train wreck that’s headed our way because of this hasty change to the federal income tax law, we’re all gonna need all the help we can get in 2018.

Kind regards,

Ted Bauman

Editor, The Bauman Letter

[tedbaumanguru-blog]

Inflation Is Staring You in the Face. Are You Prepared?

I’m a natural contrarian … and today, I’m going to contradict myself.

Last week, I wrote that it’s imperative to plan your future based on value, not price.

But prices matter too, especially in the short term. For example: Is bitcoin so valuable that it deserves a price of $11,000?

Are U.S. corporations worth so much that they deserve the second-highest Shiller price-to-earnings (P/E) ratio in history?

Do those corporations deserve a price-to-sales ratio 75% above its historical average?

In all three cases, the prudent answer to the question is no. The prices of bitcoin and stocks are out of line with their value.

But I’ve been saying “no” to another price-related question for the last nine years … and prudence tells me it’s time to change my answer.

It’s time to get ready for consumer price inflation. Are you?

Looking for Inflation in All the Wrong Places

For nearly 10 years, I’ve listened in frustration as people, who should know better, predict that central banks’ “quantitative easing” (QE) policies would produce consumer price inflation … and of course, the fabled “dollar crash.”

No inflation. No crash. Just as I predicted.

Why not?

Monetary theory says that the average level of prices is set by the total money supply divided by the real output of the economy. If money supply grows faster than output, inflation ensues.

Given the big gap between the growth of the economy and the growth of liquidity, we should have inflation.

But contrary to the misleading slang term, central banks don’t “print” money. Instead, they create reserves for the commercial banking system.

Money is only created when banks make loans against those reserves — say, $10 lent out for every $1 in new reserves.

If those loans aren’t forthcoming — or if they go to something other than consumption or investment — there’s no new money in the real economy, and no inflationary pressure.

At least not in the consumer economy.

Inflation Staring Us in the Face

What the dollar-doomsday crowd didn’t get is that QE is a peculiar sort of liquidity.

QE involved central bank purchases of bad debt held by banks from the pre-2008 housing bubble. Taking those debts off the banks’ balance sheets had the effect of boosting their reserves.

Of course, banks could have used this improved position for consumer or corporate investment loans. That’s what the politicians and bankers kept telling us.

That would have created more real-world money, and increased consumer inflation.

But, in the case of lending, supply doesn’t create its own demand.

With interest rates at historic lows, banks didn’t go out of their way to lend money (except where they could jack up lending rates, like credit cards and auto loans.)

On top of that, consumers were deleveraging, paying down old debt instead of buying new stuff. New regulations made it harder to get “liar loans.”

On the other hand, weak consumer demand meant corporations had no interest in borrowing to fund investment. In fact, corporations used the financial crisis to cut costs — firing workers and foregoing investment — which boosted their profit rates and gave them loads of cash, even as sales were flat.

So where did all that cash go? What about the QE money? What happened to inflation?

Here it is:

Since QE money wasn’t going to Main Street, it went to Wall Street instead. The average annual return of the S&P 500 is 7%, net of dividends. Since 2009, it’s been about 15.5%.

There’s your inflation, folks.

I Predict Inflation … Both Kinds

Things have changed since 2009. The economy is growing at 3% and nearly at full employment. After a decade of trying to claw it out of Wall Street and corporate coffers, ordinary people are finally starting to get their hands on some disposable income.

Accordingly, seasonally-adjusted consumer inflation just hit 2.0%, the Fed’s target.

Given that, here’s what I predict:

1. Tax cuts will fuel inflation, not investment. There is already talk of workers at U.S. corporations demanding the wage increases promised by President Trump and the GOP. More money in the consumer economy will increase demand, leading to more hiring, and thus wage inflation. Wage inflation will lead to price inflation, and vice versa.

2. The Fed will raise interest rates more rapidly than it would have without the tax cuts. But it will be under intense political pressure to limit those increases to keep the economy hot. Fixed-income investments will continue to perform poorly, even as your cost of living rises.

3. Gutting the Consumer Financial Protection Bureau (CFPB) will lead to more reckless lending, and thus more money in the real economy, adding fuel to the inflationary fire.

4. The enormous firehose of cash from slashed corporate tax cuts, tax cuts at the top of the income ladder and repatriation of foreign profits will continue to push the most dangerous inflation of all — the stock market bubble — to new heights. Until, one day, it doesn’t.

Inflation, weak fixed income performance and a growing asset price bubble. Are you ready for that?

If not, you need to consider a safer strategy now.

Kind regards,

Ted Bauman

Editor, The Bauman Letter

[tedbaumanguru-blog]

Don’t Make This Retirement Mistake

On the dashboard of my personal financial software, there’s a number.

Financial gurus tell me this number is one of the three most important in my life. One other is my credit score. The third is my age. (After all, I can shape the other two only if I’m still kicking.)

I certainly don’t measure myself against these numbers. Although I admit to paying a lot more attention to the age figure as it creeps up.

But other people use them to assess me, that’s for sure.

In fact, to hear some folks tell it, these little financial indicators are more important than a person’s morality, ethics or good works. (Particularly nasty are dating sites that require your credit score … the romantic in me says yuck to that.)

Age, credit score and … can you guess the other number? Do you know yours?

Above all, can you rely on its accuracy? What if it’s just a mirage?

You wouldn’t go out to sea without knowing precisely how much fuel, water, food and other essentials you had on board. After all, your life depends on it.

But there’s a good chance you’re heading into retirement with a faulty figure for your net worth…

Speculating on Your Future

Ever since I studied economics at university, the distinction between price and value has fascinated me.

Price is the amount of currency someone wants to part with for something at any moment in time.

$1.75 for a grande at Starbucks.

$299 for the latest video game console my daughter wants for Christmas.

Value is our subjective assessment of how useful something is. My daughter’s video game may cost $299, but I promise you, at that price there are many things I could use a lot more.

In markets, price is supposed to be an indicator of value. But prices have a way of becoming detached from value.

For example, a while back every kid wanted a silly little gadget that spins on your finger. For a few weeks they were selling for ridiculous prices because demand was so high. Once the kids figured out it was actually a boring little gimmick, the price dropped.

But trouble really starts when you introduce time into the price/value relationship. That’s where net worth comes in.

For example, right now I think my home will fetch a certain price. That price contributes a sizable chunk to my net worth. My net worth, in turn, is the foundation of my retirement plans.

I’m certain I could sell my home right now to one of the young families flooding into my neighborhood because of the good schools. They have the income to afford my price.

But I don’t plan to sell my house for another couple of decades at best. What if the young families of the future can’t afford my price?

What happens to my net worth then?

Beggar Thy Children

When we retire, we usually cash in the assets that make up our net worth, including our homes. For example, a couple I know recently sold their home and used the proceeds to acquire an assisted living apartment that will take care of them for as long as they live.

But if today’s younger generation can’t afford to buy our homes at the prices we use to measure our net worth, we may be stuck.

And it certainly looks as if the kids won’t be alright in 2037.

According to the Credit Suisse Research Institute’s global wealth report, if the world’s wealth were divided equally, each household would be worth $56,540.

But the top 1% own more than half of all wealth. The median household wealth is just $3,582. If you’re worth more than that, you’re in the richest 50% of the world’s population.

We can debate the reasons for this lopsided distribution of wealth. But there’s no debating the fact that people who reached adulthood since 2000 are on the losing end of it.

It’s particularly bad in the U.S.

On average, Americans between 30 and 39 have half as much wealth in 2017 as that age group had in 2007.

That means they will be significantly less well-off 10 to 20 years from now … unable to afford the sort of homes we take for granted today.

In other words, thanks to increasing inequality, you may be heading into retirement with faulty numbers.

Plan Your Future Around Value, Not Price

At Banyan Hill we constantly ask ourselves: What’s the Big Idea in my writing? What ties it all together?

As I wrote this article, it struck me that The Bauman Letter’s Big Idea is the absolute importance of planning your future based on value, not price.

You know, for example, that you can’t rely on current stock prices to remain the same throughout your retirement. Converting stock holdings to other assets that tend to hold their value before stock prices fall is a key strategy.

Given what wealth inequality is doing to our younger generations, if you’re heading for retirement in the next couple of decades, you may want to consider the same strategy … when it comes to your home.

Kind regards,

Ted Bauman

Editor, The Bauman Letter

[tedbaumanguru-blog]

Time Is Running Out to Turbocharge Your Investments

In the real world, ninety-nine cents will not get you into New York City. You will need the full dollar. ― Bruce Springsteen, Born to Run

I remember the first time I set foot in South Africa. It was 1984. During a layover in Johannesburg on my way to Cape Town, I waited to board with a young South African.

“Theengs are getting expaynsive in this country,” he said, in a classic Capetonian twang. “Ah just paid two bucks for a beer.”

Bucks? I thought the dollar was a “buck.” It was strange to hear a foreigner refer to his own currency that way. Eventually I became accustomed to people adopting American financial slang. It was everywhere.

But I brought more with me to South Africa than preconceived notions about our currency. I brought enough of it to invest in something priced in a foreign currency … something that has paid off extremely well for me over the years.

I was able to afford this valuable asset because the dollar was strong at that time compared to the foreign currency in question.

That’s a play you should consider making, too … before it’s too late.

Like most people, Americans have a contradictory relationship with their currency.

On one hand, many of us are proud of the strength of the dollar. It’s a reflection of the strength of our economy and our position in the world. Cheap overseas vacations in countries with weaker currencies don’t hurt, either.

On the other hand, a strong dollar is bad for many of us. It makes American exports more expensive, hurting job-producing manufacturing industries. It makes imports cheaper, encouraging consumers to buy foreign goods, and harming our trade balance.

On balance, we’d all probably be better off if the dollar were a bit weaker. And that’s definitely going to happen … especially with another $1.5 trillion in federal deficits on the way, thanks to the tax cut passed by the House on Friday.

In fact, it’s already happening. The dollar has weakened against the euro significantly this year:

And this presents an opportunity for you.

Buy Now, Earn Later

Many foreign assets are priced in foreign currencies. From equities to artwork, anything priced in a currency weaker than the dollar can be a bargain, depending on how quickly prices adjust. Typically, it takes a long time for foreign assets priced in local currency to adjust to a decline against the dollar … during which time you can find some real bargains.

That’s a great thing when you’re buying collectibles or other things that don’t generate revenue streams on their own. But when you buy an asset that produces a future stream of income, exchange-rate movements can make you rich.

Let’s say you buy shares in a foreign company priced in local currency. A strong dollar makes them cheap.

But when the dollar declines in value, as it must eventually, those foreign shares — and the dividends they produce — are going to provide you with extra income because they’ll be worth more in dollar terms than when you bought them.

In other words, your foreign investments will get an “exchange-rate turbocharge.”

They Aren’t Making Any More of This Asset

It can be difficult to trade in foreign equities. It requires either a foreign brokerage account or a U.S. broker that can trade for you, charging extra fees. It’s worth doing, but as I wrote in The Bauman Letter some months back, many people are opting for exchange-traded funds (ETFs) based on foreign stock markets instead.

But there’s another way to turbocharge a revenue-producing asset play with shifting exchange rates: Buy some foreign farmland.

For example, there’s a foreign country I know well where you can buy land suitable for forestry for less than $1,200 an acre. Historically, returns on forestry are in the 10-12% range annually. On top of that, the price of this land is appreciating at about 2-5% per year.

Now, $1,200 an acre is a good deal anywhere. So is 10-12% annual revenue. But when you convert that revenue, and the value of your land, into dollars, you’ll get more dollars over time just because the dollar is weakening.

In other words, your investment will be turbocharged.

Easier Than You May Think

The cool thing about this sort of play is that it can be dead easy. Some countries have well-developed local industries to facilitate foreign investment in agricultural land … so much so that you never have to set foot in a foreign country.

Early next year, I’m going to be presenting more information about this sort of opportunity in The Bauman Letter.

But I’m going to do more than that. I’m going to be part of an exclusive event where you can explore fantastic opportunities like this in person.

Details are coming, so stay tuned!

Kind regards, Ted Bauman Editor, The Bauman Letter

[tedbaumanguru-blog]

Bitcoin Has a Massive Problem

You’ve just arrived at the airport parking garage after a grueling flight. It’s late. It’s cold and raining. You’re tired and hungry. Home beckons.

Since it’s the year 2020, you’re paying for things with your bitcoin wallet. Naturally, the parking machines take the cybercurrency. Good thing too … you lost your real wallet, so no cash or cards.

You pay the fee. Nothing happens. A minute goes by … then two … then five. No ticket.

Twenty minutes later, your transaction goes through.

That’s exactly what’s going to happen if bitcoin’s underlying technology doesn’t change. In fact, if things carry on as they are now, bitcoin isn’t going to happen … at least not as a currency.

But there’s a fix in the works … one from which you can profit if you play your cards right.

A Decentralized Approach

Bitcoin is a cryptocurrency that exists only within a network of computers. This network is decentralized; it exists on computers all over the world. That decentralized approach is what makes bitcoin private, secure and free from government manipulation.

As I explain in the December issue of The Bauman Letter, when new bitcoins are created — a computer-intensive process called “mining” — bitcoin transactions are processed at the same time. Anybody who is trying to send or receive bitcoins must wait until the mining process has been completed to have their transaction processed.

That can be really slow … especially compared to credit card transactions. Visa, for example, processes 150 million transactions per day, or roughly 1,700 transactions per second. It could do up to 24,000 transactions per second.

The bitcoin network can only process about 6.5 transactions per second. The average transaction takes about 10 minutes to process. On some days over the last year, bitcoin transactions have taken more than 42 minutes.

As bitcoin use grows, waiting times are getting longer because there are more transactions to process.

Stick a Fork in It

Because it is ultimately nothing more than a currency, bitcoin will never succeed if it can’t do what a currency needs to do: allow people to transact. Long wait times make this impossible. Until this problem can be solved, bitcoin is nothing more than an unstable, speculative play.

There are two possible solutions: Make the amount of data processed in each bitcoin mining block smaller; or make the blocks of data bigger, so that more information can be processed at one time.

To try to reduce the size of the bitcoin block and speed things up, a majority of the world’s bitcoin miners voted to adopt a technology known as a segregated witness, called SegWit2x. SegWit2x reduces the data in each block by removing some of it from the current block and moving it to an extended block that isn’t verified every time.

But moving some data out of new data blocks potentially makes bitcoin less secure. Unless every bit of data is verified every time a block is mined and transactions are processed, it may be possible to forge or otherwise alter the data trail. That would make bitcoin useless.

To deal with this, a group of bitcoin miners with reservations about segregated witness technology initiated what is known as a “hard fork.” This involves taking the existing chain of previous bitcoin transactions — called the blockchain — and starting a new branch of transactions using a new system. This new system implemented an increased block size of 8 megabytes. That accelerates the verification process.

But the new branch of transactions can’t be called bitcoin, because it uses a different technology. So, the renegade group of miners decided to call the new cryptocurrency “Bitcoin Cash.”

And because every bitcoin that existed before the “fork” is also included in the new branch of the blockchain, bitcoin owners got a free Bitcoin Cash for every bitcoin they own.

Money for Nothing

The price of bitcoin has been on a tear recently, but declined rapidly last week:

But look at Bitcoin Cash:

A coin that had no value at the beginning of August is now worth over $1,400 each.

And as you can see, Bitcoin Cash’s gains last week seem to have come at the expense of … bitcoin.

Things Are Getting Really Weird … But There’s Money in It

The SegWit2x initiative to modify bitcoin’s blockchain was canceled last week. That’s why bitcoin tanked, and Bitcoin Cash took off. With bitcoin’s underlying speed problems unresolved, sellers panicked and turned to Bitcoin Cash.

For now, it is the only game in town. But it is only a matter of time before there is another fork, since there doesn’t appear to be any way to fix bitcoin’s underlying code that will satisfy everyone.

That means owning bitcoin could give you an equal amount of whatever new currency forks off next. Depending on how it is received by markets, that could be money for nothing … literally.

I’m a bitcoin skeptic, and I wouldn’t bet the farm on this sort of bizarre play. But money for nothing?

If you’re careful, it could be a lot more than just a line from a song.

Kind regards, Ted Bauman Editor, The Bauman Letter

[tedbaumanguru-blog]

The Smarter, Safer Gains You’re Missing

“What’s the stock market?”

If you’ve ever had a kid, you’ll know my preteen daughter wanted an answer now. Not three seconds from now. NOW.

Under such enormous pressure to impart professional expertise to my offspring, I told her it’s where people buy and sell shares in companies. Inevitably: “What’s a share?”

Eventually she had interrogated me to her satisfaction. But now I had questions.

Every day, I use the S&P 500 as a shorthand for “the stock market.” Like most major indexes, the S&P 500 is weighted by the value of each company’s total shares outstanding. That means it assigns a proportionate weight to each of its constituents with giants like Apple Inc. (Nasdaq: AAPL) having the greatest influence on the index.

But why, Daddy?

The reality is that an index-based exchange-traded fund (ETF) using market-cap weighting is a highly concentrated portfolio of ultra-mega-cap companies. In traditional S&P 500 ETFs, like the SPDR S&P 500 ETF (NYSE: SPY), Apple’s 3.89% weight is larger than the bottom 100 components combined.

That means SPY, or any other traditional index-tracking ETF, is skewed toward moves in mega-cap stocks.

Why should we consider that top-down approach to be “the stock market?” And what would happen if we didn’t?

Playing With Weights

Over the past decade, investors have been pouring money into index-based ETFs. These typically hold the stocks in the underlying index, ranked by their size.

But did you know that most of the time, the largest stocks tend to perform worse than the average stock in their sector? Historically, the biggest firm in any given sector underperforms the average stock in that sector by 3.5% a year over time.

Scaled up to the level of an entire index, that discrepancy means you might be missing a lot of gains if you stick with plain-vanilla ETFs like SPY.

What happens if you change the weighting of the stocks in an index?

The chart below shows the normal S&P 500 (black line) compared to an index that weights each company equally (red line) — i.e., 0.2% to each company regardless of size.

From 2013 to July this year, the equal-weighted index beat the S&P 500 almost all the time. In fact, if you’d invested $10,000 in an equal-weighted index ETF in 2003, you’d have earned 33% more than a conventional ETF like SPY by now.

Equal-weighted indexes like the Guggenheim S&P 500 Equal Weight ETF (NYSE: RSP, above) have been around for a while. But now someone wants to go even further and launch a reverse-weighted ETF.

Even Stranger Things: The Upside-Down ETF

The Reverse Cap Weighted U.S. Large Cap ETF (NYSE: RVRS) launched last week. It holds all the components of the S&P 500 but flips their weighting, so that the proportions of its components are determined by the inverse of their relative market capitalization. Apple is the largest stock in the S&P 500, but it is the smallest component of the new fund.

By contrast, the smallest stocks in the S&P — Navient Corp. (Nasdaq: NAVI), Chesapeake Energy Corp. (NYSE: CHK) and Patterson Cos. Inc. (Nasdaq: PDCO) — are the largest components of the fund. Combined, they are worth just 0.4% as much as Apple.

In back testing, this “upside-down” ETF outperformed both the normal S&P 500 and an equal-weighted model over the last 10 years.

What’s It For?

If you follow the ETF industry as I do, you’re probably tempted to think that the guys who design these things are running out of ideas. C’mon … an upside-down ETF?

But the back testing figures don’t lie. Both the equal-weight and the reverse-order ETFs beat the market over time.

But that’s the operative term: over time. ETFs like the new reverse-weighted RVRS are designed to take advantage of known relationships between variables over longer periods. RVRS outearns conventional indexes because, as I said above, large caps typically underperform smaller caps over time. The reverse is therefore also true.

Respect the Fourth Dimension

Allocating part of your portfolio to a proven, time-based strategy like alternative-weighted index ETFs is essential. The tested long-term relationships underlying them practically guarantee they will beat the market. They won’t win every month, but they’ll safely generate excess returns over time.

But there’s another strategy using time-tested statistical relationships that can achieve that same level of safety with even greater returns over time. It’s called the Smart Moneysystem, and it’s part of my monthly Bauman Letter newsletter.

Besides the underlying mechanics, the big difference between the Smart Money system and these alternative-weighting ETFs is that Smart Money beats the S&P 500 over time … and in the short term. For example, the Smart Money system is up 24% this year versus just 16.7% for the S&P 500.

Over the last 10 years, Smart Money’s returns were 125% higher than the S&P 500. That’s waaaay higher than the excess gains from the alternative-weighting ETFs.

So, if you’re interested in achieving solid, safe, long-term gains that beat the market, by all means play with alternative-weighting ETFs.

But if you want to do that and make serious money, follow the Smart Money system.

Kind regards, Ted Bauman Editor, The Bauman Letter

[tedbaumanguru-blog]

Debt: The Invisible Threat to Your Wealth

Our new Constitution is now established, everything seems to promise it will be durable; but, in this world, nothing is certain except death and taxes.

– Benjamin Franklin, letter to Jean-Baptiste Leroy, November 13, 1789.

As this quote from the great Founder shows, taxes have preoccupied Americans since the beginning. (Also notable is Franklin’s realism about the fragility of our Constitution … but I’ll save that juicy morsel for another day.)

Today, all the political talk is still about taxes … specifically, the Trump/Ryan plan to slash taxes on the wealthy and on corporations.

I’ve spoken about this plan before. Today, I want to turn the entire issue on its head.

I submit that our national obsession with taxation is misplaced … in fact, it conceals a far more pernicious threat to our collective and individual prosperity … one that’s staring us right in the face.

Why Do We Care About Taxes?

A silly question, you might say. But it’s one we must ask to get to the underlying truth.

We care about taxes because they reduce our disposable income. If by some miracle it were possible to pay taxes without having to reduce our expenditures, few of us would care about them.

But care we most certainly do. After all, most middle-class households pay somewhere between 15-25% of their gross income in income and payroll taxes. That’s a lot of potential household consumption and/or investment going to the taxman.

But what if I told you that taxes pale in comparison to another drain on many American wallets … and that things are going to get much, much worse soon?

The Real Vampire Squid: Debt Service

At the height of the post-2008 financial crisis, Rolling Stone political writer Matt Taibi produced a memorable quote about Wall Street behemoth, Goldman Sachs:

The world’s most powerful investment bank is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.

The first thing that struck me when I read Taibbi’s article back in 2010 was that he wasn’ttalking about taxes. After all, that sort of hyperbolic language is usually reserved for the IRS.

But Taibbi was on to something: The great sucking sound we hear is working and middle-class wealth being vacuumed upward to the wealthiest U.S. households … via credit markets.

It’s a largely invisible process. That’s because, with the exception of health care, most people assume that the prices of things like housing, education and medical care reflect supply and demand. If life in the U.S. is expensive, it’s because it’s good and in high demand.

That’s dead wrong.

The availability of cheap credit in the U.S. artificially inflates the prices of housing and education. If people had to pay cash for those things, they’d be much cheaper. But they don’t; the U.S. has one of the most debt-based economies in the world.

Why is there so much debt in the U.S.? Because there’s so much lending. Why is there so much lending? Because there’s so much debt.

It’s a circle, and it works like this:

As income and wealth inequality in the U.S. has skyrocketed over the last 30-odd years (see chart below), the richest households have increasingly put their yield-seeking cash into consumer lending markets. That’s what happens when firms like Goldman Sachs sell bundles of “securitized” mortgage loans to wealthy investors, for example.

This great gusher of excess money looking for yield has found its way into every nook and cranny of U.S. consumer markets. With so much money out on loan, consumers can bid up the prices of goods with a relatively fixed supply, like houses or college degrees.

These debt-fueled higher prices translate into increasing flows of money, in the form of interest payments, from borrowers to lenders, and thence to the ultrarich investors who provide the wholesale capital.

All the extra money needs to be used, so … back into lending markets it goes.

More credit creates more debt, and vice versa, ad infinitum. More lending and borrowing raises prices, which leads to more borrowing and lending. Consider housing and education:

We can see the result of this merry dance of debt in the following charts. The first shows the rise of household debt as a percentage of U.S. gross domestic product (GDP). It has tailed off a bit since 2008, but it’s still gargantuan:

Here’s the composition of that debt, and of the amount of disposable income the average U.S. household is “paying upward” to the folks who lend them the money to buy things like houses, cars and degrees. As you can see, household debt growth began to exceed real disposable personal income growth once again in 2016:

Mortgages dominate U.S. consumer debt, but the proportions of student and auto loans have increased noticeably since 2008:

Of course, rising post-2008 debt levels have a lot to do with low interest rates, but it’s not the whole story.

Rates will become a very big deal indeed when they start to rise again, however, our interest payments go up, and our disposable incomes shrink. It’s a ticking time-bomb ready to derail any future recovery.

Forget Taxes: Let’s Tackle Debt

The president and congressional Republicans tell us that slashing taxes will put money into our pockets. We’ll spend that money, and the resulting increase in demand will lead to investment and jobs — so much so, in fact, that even with lower taxes, we’ll balance the budget.

As I’ve argued, that’s poppycock; deficits will skyrocket. But if I’m right, how can we get more money into American pockets, so we can grow again?

It’s simple: Interrupt the vicious circle of lending, debt and the quasi-feudal extraction of interest from middle America by Wall Street and the investor class.

Reducing U.S. households’ debt load would be just as effective as a tax cut … and it would have the added bonus of reining in housing and education prices and not adding to the deficit.

Why doesn’t anyone talk about that? Maybe it’s because those who stand to get the biggest tax cuts under the Trump/Ryan plan are the same vampire squids sucking away our wealth in the form of interest.

Kind regards, Ted Bauman Editor, The Bauman Letter

[tedbaumanguru-blog]

How My Algorithm Beat the Market 10 Times Over

On October 19, 1987 — 20 years ago last Thursday — the Dow Jones Industrial Average (DJIA) lost nearly a quarter of its value in a few hours.

Back then, that was 508 points. A similar drop today would be almost 6,000 points.

Imagine that, if you will … if you dare.

On that day, traders watched in horror as wave after wave of selling ratcheted the index downward. Like a ball bouncing down a hill, each wave seemed faster and bigger than the last.

They looked at each other blankly, since none of them seemed to be doing any of the selling. They weren’t … computers used by big institutional investors were executing automated trades based on incoming price data.

In 1987, market technology was in its infancy. Today’s computerized trading is as far ahead of that as an F-35 Lightning II is ahead of the Wright Brothers.

Should you be worried? Yes … or no … it all depends on how you use today’s technology.

Do you do it the market’s way … or my way?

Warning Signs

On Wednesday, October 14, 1987, the DJIA dropped 3.8%. It fell another 2.4% the next day. On Friday, the DJIA fell another 4.6%, on record trading volume.

All eyes were on Monday.

Now, a 10% drop in three days is significant. But it’s always worse when markets end the week down. Depending on how after-hours options trading goes … and events over the weekend … traders are often poised to sell on Monday morning.

Black Monday began with a wave of selling in the Hong Kong market. Normally, London-based bargain hunters might have counteracted this, but the Great Storm of 1987 had led London’s markets to close early on Friday; most traders were told to stay home on Monday. With nobody on watch, the London FTSE 100 had fallen over 136 points by 9.30 a.m.

That was all the newfangled computers installed at large U.S. investors needed to initiate selling orders. “Portfolio insurance” algorithms started short-selling U.S. stocks and index futures.

As other computers detected this, they started selling automatically as well. The few algorithms that were programmed to suspend trading did so, decreasingly liquidity and increasing the speed of price drops.

U.S. markets soon recovered, but those who had sold in a panic on Black Monday lost a great deal of money.

Lessons Unlearnt

Black Monday wasn’t the last time algorithms have been blamed for sudden market drops. Here are some of the more prominent examples:

The August 7-10 “quant quake” of 2007. Funds specializing in algorithmic investment strategies suffered massive losses.

In the “flash crash” of May 6, 2010, the Dow dropped 9% and the S&P 500 fell 7% in just 30 minutes, as bids and offers for stocks moved far away from previous levels — in some cases leaving bids down as low as a penny and offers as high as $100,000.

On August 24, 2015, the S&P 500 plummeted 5% and the Dow dropped by 6.7% in just five minutes after the opening.

How Now?

In every one of these cases, researchers have blamed the “stampede effect” of automated algorithm-based trading systems. Unattended programs designed to cut losses reinforced each other in a downward spiral that only ended when humans intervened.

Such systems now account for more than 75% of U.S. stock market volumes. One reason is that much trading now occurs in penny intervals.

That makes trading less lucrative for market makers, who profit by playing the “spread” between the highest bid to buy and the lowest offer to sell. As they have retreated from the market, algorithms have stepped in to replace their essential liquidity-providing function.

The shift to automated trading now includes actively managed mutual funds. In March, BlackRock announced it would fire human traders and rely more on stock-picking algorithms, triggering other traditional asset managers to follow suit.

Not All Algorithms Are Created Equal

Computers now manage trillions of dollars in global stock markets. But there are two ways to use them.

The first way is as I’ve described above. Big institutional investors use automated algorithmic systems because they reduce costs and the time-wasting “friction” of human decision-making. Trades can be executed in milliseconds by the millions, generating tiny profits from each that add up to a lot.

The other way is the way we use algorithms in trading services such as Alpha Stock Alertand the Smart Money portfolio in my Bauman Letter.

In those services, we use algorithms to remove only one part of the human role in trading: emotion. We make a zen-like commitment to let the rules call the shots. Empirical back testing shows that this a true market-beater — excess gains of 600%, even 900% are possible over time.

But the Alpha and Smart Money algorithms incorporate three things that the big boys don’t.

One is a hedging strategy that tells us to short the market before it corrects.

The second is algorithms that include fundamental and sentiment analysis at the company level. Using those, we don’t sell just because a stock goes down along with the market. We keep otherwise healthy positions because we know they will rebound, as markets always have after a crash.

But the third feature of our systems is the most important: Computers running our algorithms may make the calls, but we — humans, not computers — push the button to trade. Always.

That way, when a true “black swan” event arises … one that no algorithm can possibly predict … we can step in before it’s too late.

Consider it the best of both worlds.

Kind regards, Ted Bauman Editor, The Bauman Letter

[tedbaumanguru-blog]

Health Care Coverage Has One Powerful New Trick

Earlier this year I wrote a couple of articles about the state of health care in the U.S. They generated a lot of responses — so many, in fact, that it took me over a day to read them all.

Somewhat to my surprise, the clear majority of the responses went something like this:

The U.S. health care and health insurance systems have serious problems at many levels. The problem needs to be addressed holistically, not piecemeal. No matter what one thinks of Obamacare, it would be wrong to undo it without a fully worked-out replacement.

Well, we’ve seen nine months of attempts to do just that. And all have failed — because it was clear to a majority of the U.S. Senate that they didn’t actually solve any problems, much less do so holistically.

So, we are back to the piecemeal approach, as embodied by President Donald Trump’s executive order to cut $7 billion in cost-sharing payments to insurance companies participating in the Obamacare system.

If there’s still time in your financial life, you need to start thinking of an alternative … and I know just the thing.

Skyrocketing Premiums

The $7 billion in question are the payments the government makes to health insurance companies to offset the discounts on copayments that low-income consumers have received under Obamacare.

White House Press Secretary Sarah Huckabee Sanders said: “The bailout of insurance companies through these unlawful payments is yet another example of how the previous administration abused taxpayer dollars and skirted the law to prop up a broken system.”

There’s just one problem: The money wasn’t a subsidy to insurance companies.

It was a subsidy to low-income Americans … nearly 6 million of them, or 57% of the people who get their insurance via Obamacare.

The insurance companies are simply a passthrough for the money that Trump has cut off. The money just compensates the companies for reducing high copays and deductibles for families unable to afford them. It’s not a source of additional profit for insurers.

By ending the payments, the administration has ensured that many Americans will see their premiums skyrocket. 20% to 25% is the figure being bandied about.

Unfortunately for many insurance companies, their rates for 2018 are already set. They can’t change them. They’ll just have to eat the losses … or become stingier about what treatments they’ll pay for.

But they have other options, too.

All of Us in the Crosshairs

Two groups of people that are especially vulnerable to the Trump action on the payments: Early retirees who aren’t yet eligible for Medicare and self-employed people. Those are the two groups most vulnerable to changes in the individual insurance marketplace.

That’s because, without the funding, insurance plans will flee individual insurance exchanges in droves. That will force early retirees — and anyone else without employer-provided health coverage but an income higher than the premium subsidy cutoff — to pay full unsubsidized rates for insurance directly from the insurance companies. The same goes for copays and deductibles, which will soar.

But there will be an impact on the rest of us too … including those of us who get our insurance from our employers. Here’s how and why…

As I’ve noted, Trump’s withdrawal of the payments will force the insurance companies to eat those costs in 2018. They’ll have to make up for that loss somewhere.

They’ll do so by raising the premiums the rest of us pay, spreading out the losses across all their plans. But there’s more.

In addition to the payment cuts, the president also signed an executive order calling for new regulations to encourage cheap, loosely regulated health plans. Once those are up and running, millions of younger people will move to them.

That will leave existing insurers with a smaller pool of riskier people to insure. Elementary insurance theory tells us this will result in even more premium increases.

No Savings

To make matters worse, Trump’s move will actually cost the federal government an estimated $7.2 billion next year because it will have to shell out more in premium subsidies to cover these higher rates.

Individuals with annual incomes between $12,000 to $48,000 qualify for subsidies that offset the cost of their monthly insurance premiums. Trump’s action doesn’t touch that, so those subsidy payments will have to go up to cover higher premium costs.

Over 10 years, the additional cost would be almost $200 billion. So, there will be no budgetary savings at all … the opposite, in fact.

Playing Politics With Your Health Care

The president and other administration officials have described Trump’s move as a way to put pressure on Congress to come up with a bipartisan fix. It’s unlikely that Trump would have done this if he thought he couldn’t get Congress to agree on an alternative fix — and fast.

Yeah, right.

Under these circumstances, if you still have time to put aside money for your retirement health care needs, you need to find out as much as you can about what I call the “(H)IRA”as soon as possible. It’s a special trick that can save you current tax, ensure your health care and help you have more to spend in retirement.

Because I have a powerful feeling you’re going to need all the help you can get.

Kind regards, Ted Bauman Editor, The Bauman Letter

[tedbaumanguru-blog]

Make Your Hurricane Donation Perform Like a Winning Stock Pick

I rubbed my eyes in disbelief. What I was seeing on the screen in front of me didn’t make sense.

I checked the figures again.

$750,000. Three-quarters of a million dollars. Every month. On cars and gas.

That would build a lot of transitional houses, I thought to myself. Five hundred, to be exact, at the current cost sheet. Every month.

Post-earthquake Haiti in 2013 needed those shelters desperately. But my nonprofit employer was spending millions on its own running costs.

Later that week, I learned that the low-cost self-help reconstruction project I’d helped to design for a devastated Port-au-Prince neighborhood was to be deprioritized. We were going to redirect our attention to a project that was far less efficient and effective … but more marketable for the fundraising guys back in the States.

I knew then that my time in the nonprofit sector was at an end.

As you think about donating to hurricane relief efforts, ask yourself: Would you be comfortable seeing 60% of your donation disappear down a black hole … never reaching those in need?

If you don’t apply sound investment principles to your charitable giving, that’s probably what will happen.

Even Bad Giving Feels Good

Do you have any idea how much of the money you donate to charity directly benefits the people you’re trying to help?

Most people have no idea. It’s easy to understand why.

When we invest for profit, the only reward is more dollars and cents. The act of investing is neither here nor there. We feel good when we win and bad when we lose.

Donating to charity, by contrast, is a reward in and of itself. It makes us feel good (and reduces our taxes). But unlike investing, there’s no incentive to pay attention to the “return” in terms of the impact on those you’re trying to help.

That mismatch creates the same scope for inefficiency, waste and self-dealing that we often criticize in the government.

We all know that the government isn’t subject to market forces, so there’s no automatic mechanism to ensure that it’s efficient and effective. That’s why our elected representatives monitor government activity closely — after all, it’s our money!

But few people pay any attention to what happens to their money inside a nonprofit organization.

For some reason, we trust them in a way we’d never do for the government.

Experts at Spending Money

Don’t get me wrong. There are many effective and efficient nongovernmental organizations (NGOs) out there. I worked at some in my years in Africa.

They tend to have the following characteristics:

No more than 25% of their outlays go to their own internal costs — salaries, overhead and so on (the “charitable commitment” ratio).

They spend 30 cents or less to raise one dollar in donations (“fundraising efficiency”).

They do not carry financial surpluses year-to-year.

They publish honest and self-critical annual reports with full transparency, including executive salaries.

They are regularly audited by external auditors.

These characteristics are especially important for disaster response and relief organizations like those that are soliciting funds for victims of Hurricanes Harvey and Irma. Such organizations do not have research and program development costs, which can make an NGO’s overheads look less efficient than they really are.

What You Can Do

After Hurricanes Katrina and Sandy, and the Haitian earthquake, the American Red Cross (ARC) received stinging criticism.

The ARC was raking in millions. But it was not always spending that money effectively, or even for the purposes for which it was given. It had a worrying tendency to prioritize publicity over relief efforts, since it helped to generate more donations.

Worst of all — for me anyway — the ARC raised over $450 million for Haiti but built very few houses for earthquake victims.

The ARC is in better shape now — partly thanks to the advent of research tools for charitable givers, and, for once, the Internal Revenue Service (IRS).

Like publicly traded companies, which must file documentation with the Securities and Exchange Commission annually, all U.S. 501(c)3 nonprofits must file a Form 990 with the IRS.

This publicly available information allows you to discover an organization’s charitable commitment and fundraising efficiency ratios, along with other financial information such as executive salaries.

Several organizations use Form 990 information and other input to rank nonprofits and provide more detail on their activities so you can make more informed charitable giving decisions. They include:

www.charitynavigator.org.

www.give.org.

www.givewell.org.

www.guidestar.org.

These sites are good places to start. But just as you would do when considering investing in a company, you need to do more. Google the charity with the word “+criticism” next to it — for example, “’American Red Cross’ +criticism.”

What you find may surprise you … but that’s better than wasting your hard-earned money.

Kind regards, Ted Bauman Editor, The Bauman Letter

[tedbaumanguru-blog]

Don’t Let Labor Day’s Dark History Repeat

My father, Bob Bauman, has traditionally published a holiday-themed Sovereign Investor Daily article on special occasions like Christmas, Thanksgiving and the Fourth of July.

He’s a fount of knowledge about American traditions. He deftly weaves in tasteful commentary about current events.

He’s done a few on Labor Day, too. But this year it falls to my regular Monday column. So, continuing the family tradition, here goes nothing.

The official story is that “Labor Day is a public holiday, celebrated on the first Monday in September, honoring the American labor movement and the contributions that workers have made to the strength, prosperity, laws and well-being of the United States.”

The truth is darker … but it provides a ray of hope in troubled times.

The First Gilded Age

The U.S. economy transformed itself after the Civil War. An agrarian nation with a little manufacturing in the Northeast became an industrial powerhouse.

Millions of Americans left their farms to work in factories and mines, and on the railways that connected them. For the first time, the U.S. had a true industrial working class.

Like today, to which it is often compared, the late-19th-century Gilded Age was riddled with monopolies. Steel and the railways were two of the most consequential. Powerful firms could set prices at will.

They also had more control over their workers than anything any of us have ever experienced.

For example, the Pullman Palace Car Company built and ran the town of Pullman, south of Chicago, for its railway workers. In common with many successful capitalists, the firm’s founder, George Pullman, personally designed the place to test his theories about how to improve the human condition.

Things did not go well.

The Pullman Strike

Pullman forbade his employees to own their own homes in the town, which he ran as a paternalistic dictatorship. The Pullman Company supplied all utilities and owned all retail outlets. With this monopoly, Pullman manipulated prices freely, just as it did in its railway business.

In early 1894, Pullman unilaterally reduced its workers’ wages … but not their rents, or the prices of gas and water.

The American Railway Union (ARU), led by Eugene V. Debs, quickly organized the enraged workers. (Debs later ran for president as a socialist five times; President Woodrow Wilson imprisoned him for sedition.)

In June, under the ARU’s guidance, the Pullman workers launched a crippling strike that shut down the U.S. railway system west of Chicago. It eventually involved 250,000 workers in 27 states.

The press portrayed the strike as organized by immigrant rabble-rousers who had brought socialist and anarchist ideas with them from Europe.

In mid-July, President Grover Cleveland ordered U.S. Attorney General Richard Olney to find a way to end the strike. (Outrageously, Olney, a former railroad attorney, still received a $10,000 annual retainer from the Chicago, Burlington and Quincy Railroad, on top of his $8,000 federal salary.)

Olney and the railway companies called in the U.S. Army and United States Marshals, who shot 30 workers to death and wounded 57 more before it was all over.

Did You Know…

Congress quickly voted to make the first Monday in September a national holiday called Labor Day. President Cleveland signed the law six days after the end of the strike. He hoped to assuage the concerns of nervous workers in other parts of the economy.

In fact, the U.S. already had an informal workers’ day — May 1, still celebrated nearly everywhere else in the world as International Workers’ Day.

Cleveland felt that celebrating labor on May 1 would strengthen the U.S. socialist and anarchist movements. He also wanted to discourage solidarity between U.S. and Canadian and European workers, who celebrated May 1.

That’s why we celebrate Labor Day in September.

Lessons Learned?

The Gilded Age was like ours in many ways.

Powerful monopolies and bigger-than-life businessmen … massive inequality of wealth and political influence … disorganized workers, increasingly frustrated by the imbalance of power … contempt for immigrants.

The country survived … but not by doubling down on the dog-eat-dog attitudes of the Gilded Age.

It did so by making sensible reforms that met the needs of as many Americans as possible. In fact, conditions in the U.S. after World War II, our period of greatest national prosperity and unity, were essentially the opposite of the Gilded Age.

That suggests to me that there is a way to make this country great again: Learn a bit of history, and act on that knowledge.

Kind regards, Ted Bauman Editor, The Bauman Letter

[tedbaumanguru-blog]

Is Your Portfolio About to Burn to the Ground?

The economy is a forest. Individual stocks are like trees.

As in, “We can’t see the forest for the trees.”

Most of us focus on specific assets and the markets they inhabit. A basket of stocks in the S&P 500, for example.

There’s danger in that.

If you’ve chosen well, and your picks show nice returns, that hyperfocus might miss trends that say it’s time to run for cover.

Those trends show up in the real-world economy before they affect stock markets. But warning signs exist even in stock markets …. if you know to look for them.

I looked … and those warning signs are flashing fire-engine red. Learning to interpret them could help your portfolio survive the next recessionary fire.

Dude, Where’s My Profit?

Let’s start with an indicator that reveals what’s going on in the “real” economy of physical goods and nonfinancial services. It leaves out the FIRE sector (finance, insurance and real estate).

Gross value added of nonfinancial companies after inflation measures the net value of goods and services produced after adjusting for production costs.

When it’s negative, it means companies aren’t making money from selling their wares. If they’re showing profits in their quarterly reports, it’s coming from somewhere else — cost-cutting, layoffs, asset sales and so on. Those aren’t sustainable.

Moreover, whenever this indicator falls below zero on a year-on-year basis, the U.S. economy enters a recession — every single time:

This measure just turned negative. Why should this time be any different?

The Slinky Cycle

Think of the economy and its business cycle as a compression wave — a Slinky, for example.

As economic activity increases, firms make more profit. They use that profit to invest in new productive capacity, hire workers and grow.

That spending ripples out through the economy, as workers spend wages and producers of capital goods expand their own operations, and so on.

Eventually, however, that expansionary wave slows down as markets become saturated. Profits start to fall — as in the chart above — and companies cut back on investment, jobs and expansion plans. That also ripples through the economy.

The Slinky contracts.

Given this expansion/contraction dynamic in the economy, we can use changes in pretax profit margins over time to get a sense of where we are in the business cycle.

As the following chart shows, profits tend to rise at a steady rate, level off, then fall, signaling a looming recession. The U.S. is now in the mature stage of the cycle — roughly 80% of the way to recessionary conditions:

This pattern has held true for every recession since 1949. Why should this time be any different?

Chasing Unicorns

When the business cycle is petering out, sending us into the contraction phase, the degree of correlation within and between price movements of various asset classes — such as stocks, bonds and commodities — begins to decline.

Asset prices that usually move together start to move independently. Oil futures drop but retail sector stocks rise, for example. Transport stocks suffer but some automakers do well.

Why is this?

When there’s a bear market, investors tend to be conservative. It’s too risky to go chasing after individual stocks, even if analysts like them.

For example, if Firm A and Firm B are in the same industry, there’s no reason why one of them should perform better than the other in the short term if market conditions for each are identically weak.

Sure, some firms have great innovations and break free from the pack.

But cautious investors are much less likely to support such stocks in a bear market, where preserving capital is key. For that reason, correlation tends to be higher in a bear market.

By contrast, correlation tends to fall during the final stages of a bull market, as stock pickers chase individual stocks that report superior results, even as the rest of the market declines.

For example, Atmos Energy Corp. (NYSE: ATO), a Texas natural gas distributor/pipeline company, is soaring even though the natural gas sector is in dire straits.

Recently, the Chicago Board of Exchange’s Implied Correlation Index for the S&P 500 (JCJ) has plummeted … just as it did in 2008 and late 2014, just before the big drop in January 2015:

This isn’t just a U.S. phenomenon. In a note published earlier this week, Morgan Stanley notes that assets across the world are the least correlated in almost a decade.

Thinning the Herd

A fall in correlation is due in part to the fact that as a business cycle nears its end, fewer firms remain profitable. This can happen even if the market is still rising, but driven by a few big stocks or sectors.

That’s happening right now. Fewer and fewer U.S. stocks have been rising with the market as it reaches new highs.

The gap between the overall market index and a measure of the proportion of stocks that are trading below their 200-day moving average — only 57% — is disturbingly wide (the red line):

To me, that suggests a business cycle on its last legs.

Here’s the thing about forests and trees.

A big tree in the middle of the forest has no idea a fire is raging on the edge of that forest. The big tree is growing well, thriving, secure … until the fire arrives and burns it to the ground.

There was nothing wrong with the tree … but it still went down with the forest around it.

As the business cycle winds down, which stocks will be like that big tree in the forest?

The Profitable Hedge

Even if an investment has a lower return than the market, it can improve the performance of a portfolio if it has a low correlation to the other investments in that portfolio. When they go down, the less-correlated position stays up.

We designed my Alpha Stock Alert  service and the Smart Money service embedded in The Bauman Letter  for low correlation with the stock market. In rigorous backtesting, they both beat the market by triple digits in the aftermath of the 2008 crisis. They’ve also done better than the current bull market.

By keeping one or both of those portfolios in your larger mix of investments, you can hedge against the coming forest fire … and make money at the same time.

Because you never know…

Kind regards, Ted Bauman Editor, The Bauman Letter

[tedbaumanguru-blog]

Hide From Washington’s Thought Police … Now!

The Minister of Housing really didn’t like me. At all. Everyone around the polished walnut conference table in her Pretoria office could see it.

The fact that I was married to her personal secretary didn’t help.

I’d been a thorn in her side since the day she’d made a strategic alliance with the South African housing rights group for whom I worked. She wanted an easy ride. Ululating homeless people praising her in photo ops.

She got that … but she also got my colleagues and me, who relentlessly highlighted in the press the hypocrisy of her department’s evictions of those same people.

At first this didn’t really matter to me. I was fighting the good fight. But as the years went by, I realized the cost.

By 2007, I was tired. I wanted to do something else with my life. Let the younger folks take to the trenches.

But as I put out feelers for new employment, I discovered the dark truth … I’d been blacklisted for my views. I was unemployable.

Think it can’t happen to you in the good ol’ U.S. of A? Think again.

And take action before it’s too late.

Crossing a Line

Last week, news reports revealed on July 17 the Department of Justice (DoJ) issued a search warrant to a California web hosting company called DreamHost.

The warrant demanded information related to a website that encouraged people to protest at President Trump’s inauguration.

The search warrant shocked the legal world … and privacy bugs like me.

For the first time, the federal government has demanded to know the identities of people who visited a specific website without any evidence of a crime having been committed. As DreamHost’s answering filing says:

The government’s search warrant (“Search Warrant”) here requires non-party DreamHost, LLC (“DreamHost”) to turn over every piece of information it has about every visitor to a website expressing political views concerning the current administration. This information includes the IP address for the visitor, the website pages viewed by the visitor, even a detailed description of software running in the visitor’s computer. (Underline added.)

This has never happened before.

Normally, the DoJ limits such search warrants to information about the owners of websites. That information is specific enough to meet the Fourth Amendment’s stipulation that “no warrants shall issue, but upon probable cause … and particularly describing the place to be searched, and the persons or things to be seized.”

In other words, under the Constitution, the government can’t go on a fishing expedition for anonymous names.

That’s precisely what the DreamHost warrant does. The DoJ has made no effort whatsoever to limit the warrant to actual evidence of any crime.

It only makes matter worse that the defining characteristic of the visitors to the website in question is the expression of political dissent.

That crosses a very dangerous line indeed.

Freedom Knows No Party

Naturally, our political preferences shape our first reactions to something like this. If we like the president, we may tend to support the DoJ’s move. At the very least, we’ll be sympathetic.

But just imagine that this was Hillary Clinton’s DoJ, and the website in question was devoted to opposition to her.

You see the problem.

We have one Department of Justice, one government, one set of laws and one Constitution. Not one for Republicans and one for Democrats.

Any precedent that government sets can be used by future governments. It doesn’t matter who’s in charge.

Yes, It Has Come to This

Normally when I write about strategies to protect your online privacy, I’m thinking about hackers or abusive commercial data harvesting.

Now I must include your political views in that list.

There is a way to prevent government snoops from finding out what websites you visit and what you do on them. It’s called a virtual private network (VPN). I’ve written about them before.

A good VPN makes it impossible for anyone to know who and where you are when you surf the web. When you visit a website, the IP address (your computer’s postal address) appears to be somewhere else.

Mine, for example, typically appears to be in Iceland. Or New Zealand.

That makes it useless to the goons issuing unconstitutional search warrants.

I eventually learned that the South African government was tapping my phone, reading my emails and telling potential employers to avoid me. It’s one reason I’m writing to you now and not sitting on the beach near my home in Cape Town.

It’s also why I use a VPN.

Unless you have a Plan B for a second life, you should use one too.

Kind regards, Ted Bauman Editor, The Bauman Letter

[tedbaumanguru-blog]

I Won’t Get Chipped … and Neither Should You

Paranoiac [par-uh-noi-ak]: A tendency on the part of an individual or group toward excessive or irrational suspiciousness and distrustfulness of others

If you’ve followed the entertaining saga of former White House communications chief Anthony “The Mooch” Scaramucci, you’ll be familiar with the term “paranoiac.” Apparently the Mooch thinks ex-Chief of Staff Reince Priebus is one.

The question is: Am I one, too?

Recently my colleague Paul Mampilly wrote that he’d be perfectly happy to have a microchip implanted in his body if it made his life easier.

I disagree, to put it mildly. Does that make me a paranoiac, a Luddite … or prescient?

Privacy or Convenience?

Three Square Market, a Wisconsin company that makes self-checkout gear for corporate and prison cafeterias, recently started implanting microchips in its employees.

The company claims it’s doing this to make life easier for those employees. They won’t have to use cash or cards to pay for snacks, enter a password in their computer, or use a key or card to unlock doors.

All they must do is consent to a rice-sized radio-frequency ID (RFID) microchip in their hand.

(A skeptic might argue that this exercise is really a form of viral marketing — by creating a media stir, it attracts attention and business. It might just work … especially in the prison warden market, where such technologies are the stuff of dreams. But I digress.)

This has led to a big outcry. Paul Mampilly feels this is wrong: He says initial resistance to innovative technology is always misguided:

… I’m skeptical of media stories that question new technology that can make our lives better … especially when it comes to something that’s as frequent as paying for things, like how RFID chips are being used. …  The bottom line for me on this is that there is a revolution brewing in financial technology. And it’s clear that many people are ready to throw off old ways in terms of paying for things in order to have greater convenience, and the freedom of being able to do things without a wallet or a form of payment.

Paul says: “… When you look back at history, the pessimists have been utterly and completely wrong on technological developments.” He cites initial skepticism attending the invention of printing, email and Facebook, which critics thought would make us crazy, stupid and immoral, respectively.

No Such Thing as a Neutral Technology

It’s true that people have worried about the impact of new technologies throughout history. Usually those initial concerns turn out to be unfounded … at least when considered over a long enough time frame.

But technologies do change us … usually in unforeseen ways.

Consider Paul’s examples:

The invention of printing enabled mass communication, disrupting Europe’s socio-political order and resulting in the fragmentation of Christendom and the collapse of feudalism.

Email may not be worse than marijuana, but it has radically transformed the way we communicate, both qualitatively (“IMHO”) and quantitatively. (“Inbox bankruptcy” is an actual thing.)

I happen to agree that Facebook has made us less moral, at least politically. The initial worry was that rapid information flows would eliminate time for introspection. Whether that’s true or not, nobody can deny social media’s role in self-segregating society ideologically, giving rise to ever more extreme political opinions and making democracy increasingly unworkable.

The Science of the Possible

In my writings, I’ve consistently argued that as technologies change, so too do the principles that govern the use of that technology.

For example, the authors of the U.S. Constitution would undoubtedly consider the electronic surveillance practices of the U.S. government to be antithetical to that document. Most modern decision-makers, however, accept them because of their purported benefits for law enforcement, combating terrorism, etc.

Those benefits, of course, only became apparent once the technologies were invented — thus posing a brand-new moral and political question asking for an answer.

Predictably, those in power answered it in a way that meets their own interests, and found ways to justify their choice. That’s always how the emergence of new “benefits” from technological innovation leads to a shift in attitudes toward other things, like privacy and personal choice.

Crucially, however, these attitudinal changes depend on how power is distributed in society. After all, the rest of us have views on these matters too. The question is whether anyone at the top pays attention to us.

Electronic surveillance is attractive to unaccountable bureaucrats and politicians, who like the power it gives them (but quickly change their minds when they are the targets!).

Whether or not a technology like this is deployed for good or ill, however, depends on whether ordinary people like us are powerful enough to influence matters.

Right Idea, Wrong Time

This is precisely why I object to the implantation of microchips.

Any technology is as useful as the uses to which it is put.

If we lived in a society where I could be certain that implantable microchips would not be abused by powerful forces in the public and private sectors, I’d agree with Paul.

But we don’t.

We live in a society where an increasingly unaccountable corporate-government elite gets away with pretty much whatever it can. Good intentions are swamped by self-serving assessments of the “benefits” of innovative ways to erode our liberty.

That’s why I’m not getting a microchip … even if it makes paying for coffee a little less convenient.

I want to know what you think. Would you ever consider getting a microchip implanted in your body? Let me know in the comments section below, or you can send me an email at [email protected].

Kind regards, Ted Bauman Editor, The Bauman Letter

[tedbaumanguru-blog]

Beware the Sharing Economy

I had no idea it could be so hot at night this far north. Silly me.

At least, I thought sarcastically, I’m lying on my back in the cool mud, staring up at a greasy generator. Even though the genny was hot, it was much hotter inside the RV. And by this point in the evening’s chaos, there were as many mosquitoes inside as there were outside anyway.

This was not the vacation I’d envisaged.

Driving a recreational vehicle across the U.S. is tiring. The decrepit state of the U.S. Interstate System — especially in Gov. Scott Walker’s hyperaustere Wisconsin — ensures that. We’d made it to Madison from Atlanta in two days. We had another day of driving ahead of us to get to northern Minnesota.

But we’d had a splendid dinner at our traveling companion’s mother’s house, and the margaritas were working their magic.

The tail end of that magic is always a good sleep, so I headed out to the RV to start the generator and fire up the air conditioning. There wasn’t enough room in the old farmhouse for all of us, so we planned to stay out in the RV overnight.

There was just one problem: The power transfer switch had failed, so we had no power. And it was over 90 degrees inside the big rig…

You Pays Your Money, You Takes Your Chance

I’m a boat guy. RVs are similar in many ways — especially their mobile electrical, water and climate systems. Even though I’d never used one, our road trip to Minnesota seemed like a great idea.

So, too, did the idea of renting one through a peer-to-peer RV rental service called Outdoorsy.

Outdoorsy touts itself as the “Airbnb for RVs.” It provides the transaction interface, and low-cost insurance to make owners willing to rent out their property, but leaves the details to owners and renters. Some elements of the deal are standardized, but price setting is up to the owner.

The same applies to maintenance of the RV itself, as well as any problems that occur on the road. Unlike a professional rental company, Outdoorsy’s model takes no direct responsibility for ensuring the roadworthiness of the unit. That’s up to the owner.

If you’re lucky, the RV has been well-maintained. If not … well, to compensate for that risk, Outdoorsy offers a “24/7 Roadside Assistance” package for renters. It sure sounded rosy on the website and in the emails.

I’m sure you can see where this is going … so-called “24/7 Roadside Assistance” failed miserably in our hour of need.

Best-Laid Plans

On the first day of our trip, the key for the RV’s storage lockers broke inside the badly corroded lock to the gas cap. That meant we couldn’t access any of the hookups for electricity, water or sewer.

Since we were planning to rely on the generator for power at our friend’s house in Madison, however, we decided to deal with that on the way to Minnesota.

In Madison, however, the generator stopped sending power to the RV. It ran, but there was no juice. All breakers were in normal position. (The problem lay with a faulty automatic power transfer switch.)

That left us without any power source, and a rapidly draining battery … after dark on a hot, humid, thunderstorm-riddled farm road.

Outdoorsy’s so-called “24/7 Roadside Assistance” was essentially useless.

Since neither the key nor the power problem was related to the mobility of the vehicle, on-site support wasn’t available except at our expense. We understood that. Outdoorsy’s contribution was limited to locating a local mobile RV technician for us.

After a couple of hours of waiting, however, the roadside-assistance folks called to say the only one they could find wasn’t answering his phone, and that I should call him instead.

He never replied to my messages.

And I never heard from Outdoorsy again, despite several emails … and even a post on their Facebook page. (They didn’t even respond when I asked them to comment on this article — three times.)

In desperation, I went to a Camping World outlet. The employees refused to work on the RV since we didn’t have written permission from the owner.

Nobody ever mentioned that during the rental process.

The Sharing Economy ≠ Shared Risk

This is an important lesson.

The sharing economy is supposed to offer greater flexibility at lower cost than the traditional institutional-corporate model. It does this by connecting independent suppliers and consumers via “platforms” like Uber, Airbnb … or Outdoorsy.

It’s a great model in theory. It’s certainly profitable for the platform innovators, who don’t get directly involved in the supply of the services in question, and thus enjoy minimal overheads.

But this comes at a cost … and increased risk for you, the consumer.

Uber drivers occasionally assault passengers (and vice versa). Airbnb hosts lie about their accommodations, and on occasion have turned out to be psychopaths. Outdoorsy rental RVs turn out to be unreliable.

The problem with abandoning the traditional model of supplier responsibility for service and support — like a car-rental company or a hotel that assume responsibility for fulfillment of the contract — in favor of “sharing” is that you can be left out in the cold … or the heat, as the case may be.

Until someone begins to innovate specialized service firms that fill in the huge risk gap in the sharing economy — such as roving independent support technicians — you should probably stick with the old-fashioned ways of doing things, at least when it comes to big-ticket stuff like vacations.

After an evening in the Wisconsin mud, I know I will.

Kind regards, Ted Bauman Editor, The Bauman Letter