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Hello everyone! Welcome back to a new week of economic knowledge. I’m going to enlighten you this week with the yield curve. Very few probably heard about this concept, but it is a very important indicator to economists.

A yield curve is a line that plots the interest rates of bonds with differing maturity dates. It is vital to compare bonds with the same credit rating. For instance, let say company A has a grade C bond, it should only be compared with another company with a grade C bond. This is due to riskier companies have higher yields to compensate for the risk.

Many analyst used the benchmark for other debt in the market. For instance, a financial advisor may compare a 30 US Treasury bill to a 30 year mortgage rate. Another important usage of the yield curve is to predict changes in economic output and growth.

The yield curve takes 3 main shapes: normal, inverted, and flat. The shape gives economists and analysts the idea of future interest changes and economic activity. Let’s discuss the differences between the shapes and what they indicate.

A normal yield curve is upward sloping, which determines that longer maturity bonds have a higher yield compared to shorter-term bonds. The yield curve also indicates the yields on longer-term bonds may continue to rise due to periods of economic expansion. Although holding longer term maturity debt gives you a better return, you are susceptible to interest rate risk. In a rising rate environment, which we are in now, the value of your longer term bond will decrease. Therefore, many investors will sell off their longer term bonds and purchase shorter term securities.

An inverted yield curve is downward sloping, which determines that short-term yields are higher than the longer-term yields. The yields of longer-term securities may continue to respond due to periods of economic recession. The yields on longer-term securities could be trending down when market interest rates are forecasted to get lower for a foreseeable future to accommodate ongoing weak economic activities. Therefore, businesses and governments can acquire investment capital at lower costs. As a result, an increase in investments can jump start a weak economy.

Finally, a flat yield curve demonstrates that shorter-term bonds and longer-term bonds are very close to each other. A flat yield curve can arise from normal or inverted yield curve, which indicates an economic recession. When the economy is transitioning from expansion to recession, yields on longer-maturity tend to fall and shorter-term securities are likely to rise. On the other hand, economy getting jump started into an expansion from weak economic development will drive longer-term bonds to rise and shorter-maturity securities to fall.

Our economy is currently in an economic expansion, but the yields on longer-term maturity are decreasing. Does this mean we are heading into a recession?

 

Unless you’re living under a rock, you have been noticing the stock market has been tanking. Ok that is outrageous for me to say. Only a economics nerd would know this stuff. You’ll probably have more exciting and better things to do.

Now back to the topic of the stock market. It has been demonstrating volatile swings due to the recent bombarding of news. From the previous posts, we learned the efficient market theory incorporates readily available information and displays into the stock price.

You must be wondering what news was just released? Well the Technology sector was slammed recently, which was the main driver of the the downfall of the stock market. The NASDAQ, which is a tech-heavy index, has fallen 2.74%. This essentially eliminated all the gains the sector has made in the beginning of the year.

Let’s dissect why the technology has been failing over the past two weeks.

Facebook has been under scrutiny by the government and the public. Facebook users are wondering if they can trust this social media company with their privacy and information. Facebook’s data was breached the political consulting firm Cambridge Analytica. This firm abused this data to optimize their algorithms to better target their audience. As a result, Facebook stock fell 2.75% due to the failure of protecting their consumers’ information.

Another technology company that has been criticized is Snapchat. This alternative picture delivering social media updated their app in the beginning of the year. From a business perspective, it was a brilliant maneuver to boost advertisement revenue. However, from a consumer satisfaction perspective, it was a disaster. Users complained about the new design and found it annoying to use. As a result, Snap went down 8.83% because they forgot to consider their customers in their new update.

Your favorite online website Amazon has been attacked by President Trump due to abusing the deal with United States Postal Service. Although USPS is profiting from the deal, good ole Donald wants the country’s mail delivery service to charge corporate giant more money on each package. Amazon’s stock decreased by 5.21% as people expect more government regulation on this company. The increased regulation can lower Amazon’s expected earnings.

The electrifying car brand Tesla faced several problems recently. First, the company witnessed its first semi-autonomous car accident, which was forced to halt operations. The public was scared by this news as they see autonomous driving as a danger to public health.  Another big issue is Elon Musk alerted investors the company is going to miss the Model 3 production target. These two detrimental situations dropped Tesla’s stock price by 5.13%.

The list can go on as other tech companies have been struggling. Ultimately, technology’s sector poor performance drove the NASDAQ and Dow Jones down.

Last week we learned about the efficient market theory. Yeah, yeah, yeah I know it was literally 7 days ago! I’ll save all you lazy bums some time and explain what it is again. Efficient market theory is the stock market incorporating all available and relevant information immediately into stock prices. If you religiously believe in this theory then you also believe it is impossible to beat the stock market. Therefore, you’ll just invest your money in a diversified mutual fund and take whatever return the market gives you.

However, many of are jumping up and down saying that it is not true! Not everyone invests in a diversified mutual fund to get the market return. I bet a very few people out there actually do this. Many people choose their own stocks and hope to beat the market. As a result, these rebels don’t believe in the efficient market theory.

Believe it or not, these people are also correct about the stock market. Before, all of you start yelling at me about how confusing I’m being right now. Let’s all take a deep breath and I will explain the basics behind this point.

Everyone has their own philosophy behind the efficient market theory. Individuals believe it to a certain extent. There are 3 basic levels about the efficient market theory, which can be weak, semi-strong and strong.

Weak-form efficient market theorists believe that the market is efficient in reflecting all market information. This hypothesis assumes that the rates of return on the market should be independent. Therefore, past rates of returns should have no effect on future returns. The most popular tests executed by weak-form efficient market believers are statistical tests for independence and trading tests.

On the other hand, semi-strong form of the efficient market theory indicates the market is efficient in reflecting all publicly available information. As a result, stock prices adjust quickly to new information. Most traditional investors believe in this sort of efficient market theory. These type of theorists conduct event tests and regression series tests.

Lastly, the final form of the efficient market theory is strong form. This hypothesis implies the market is efficient at reflecting all information that is both public and private information. Interestingly enough, if this theory is true then no average investor can profit when new information is released. The typical investors who believe in this theory are insiders, exchange specialists, analysts, and institutional money managers.

I hope this clears the confusion between all the different types of efficient market theory. Whatever you believe, you should manage your risk in the stock market. Never invest too much money or a loss can lead to detrimental consequences in your life.

All in all, ride the bull or claw down the bear (just nerdy finance slang-just leave me alone).

The stock market is one of the most common place invested by ordinary people like you and me. When people invest in the stock market, they are gaining ownership of public companies. Investors are hoping for the stock market, so they can make money off capital gains and dividends.

Capital gain is the increase in the value of a capital asset that gives it a higher worth than the purchase price. For example, if you bought a stock at $100 per share and the share price goes up to $150. You just made $50 from just capital gains! On the other hand, a dividend is money paid to stockholders, normally out of the corporation’s current earnings or accumulated profits. However, not all companies give dividends to their shareholders. These companies usually reinvest the dividends into their business operations to propel growth. As a result, the expansion in business can raise stock prices and investors gain profit from capital gains.

Now coming back from the tangent. You ever wonder why stock prices move the way they do? Like why does a stock price go up or crash? The efficient market theory will explain this to you. In simplified terms, this theory says the stock market will immediately all available information into the stock price. Therefore, the stock price will instantaneously move when news is released.

This past week, Facebook has been under scrutiny with their business practices and protecting their consumer’s information. Cambridge Analytica, political consulting firm, breached Facebook’s data, which helped create data modeling and performance-optimization algorithms that were used to target boat loads of adds to different audiences. This powerful weapon helped the firm pull off one of the most dramatic political upsets in modern history with Donald Trump becoming president of the United States.

Due to this controversy, many Facebook users were concerned with Facebook’s trust with their information. As a result, many users stopped going on this social media website. Consequently, Facebook lost business from many companies as they stopped paying for advertisements on the website. This means Facebook’s expected earnings will be earnings.

With all this negative information, guess how long it took the stock market to reach? To help you with the answer, scroll up to the efficient market theory. Still don’t know the answer? If you answered immediately, you are right! Below is the stock price of Facebook when the Cambridge Analytica scandal came out.

Ultimately, the stock market is a very efficient machine. It processes all available information into stock prices. Additionally, it incorporates new information immediately. Therefore, if you have a crystal ball and know what new information is coming out then you’ll be the richest man alive. You’ll know exactly when to invest and when to short stocks. All in all, beating the market is more difficult than it seems.

 

You ever realize the price of goods and services are generally more expensive in the future? That seems really unfair! Why should I pay more for a product just because I didn’t buy it last year?

This my friend is known as inflation, which is the sustained increase in the general level of prices for goods and services in a country. For example, if the inflation rate is 2% annually, then theoretically a $100 phone will cost $102 in a year. As a result, a consumer’s purchasing power will decrease.

Purchasing power is the value of a currency expressed in terms of the amounts of goods or services that one unity of money can buy. As inflation raises, purchasing power goes down. That’s a simple correlation. However, there are many unforeseeable consequences to this. For instance, this will lead to a higher cost of living, high interest rates, and falling credit ratings.

You must be wondering what causes inflation. There are two theories that are generally accepted by economic nerds. Demand-pull inflation and cost-push inflation.

Demand-pull inflation theory simply says too much money is chasing too few goods. If the demand for a product is higher than supply, then prices will increase. This is most popular in growing economies. The graph below will give you visual understanding on the matter.

On the other hand, cost-push inflation simple says if business input costs rise then product prices will also rise. This is due to businesses’ desire to maintain their profit margins. The most common ways input costs increase are higher wages, taxes, and import costs. The image below shows you the graphical representation of cost-push inflation.

If you were following the markets this week, the Consumer Price Index (CPI) rose 0.2% last month. The CPI is an economic indicator that measures the average price of household goods and supplies. This is the most common indicator used by economists to measure inflation.

The results basically told you are paying two hundredths of a penny for all your goods. This may not seem a lot, but money adds up quickly when you make multiple purchases throughout the month.

All in all, try not to let your lowered purchasing power ruin your day.

This week we are going to take a break from the economy and discuss more technical topics in the field. We all definitely heard of bonds, stocks, derivatives, and other investment instruments. However, you ever wonder if your investment is into the debt or credit of a company?

Let’s discuss something we’re most familiar with, which is debt. Debt is typically money that is due or owed to another person or party. The most common types of debts personal households have are credit card payments, medical bills, student loans, and various utility bills.

However, businesses have different forms of debt to finance their company. Just like our personal expenditures, businesses have to pay back the principal payment plus interest at maturity when they undergo debt.

There’s a lot of advantages of debt financing for a business. For instance, the lender of the loan has no control over your company’s operations. Once a borrower pays a loan, your communication with your financier can end. Additionally, debt financing is attractive because it is tax deductible. Therefore, company’s expenses can decrease with the tax shield.

However, there’s always negatives associated with the positives in the business world. When receiving debt financing, lenders always look at the company’s future ability to pay back the loan. The lender has to analyze if the borrower can pay back the loan when the economy hits the recession stage or undergoes a terrible business year. The inability for company to pay back its debt can damage their credit rating and hinder their ability to grow.

Now let’s talk the other phase of business financing: equity financing. Equity financing is the process of raising capital through the sale of ownership in the company. For many businesses, equity financing starts with venture capitals or angel investors. These are the people you see praised at Silicon Valley and the ABC TV show “Shark Tank.” However, many of your parents and you purchase Apple, Facebook, and Google stocks on investing portfolio. Believe it or not, you are performing equity financing.

Business owners desire to use equity financing to raise capital for a variety of reasons. For instance, equity investors take risk when purchasing shares of your company. So, business owners owe no future money because they have been given small ownership of the company already.

Unfortunately, there are downfalls with equity financing. As an illustration, businesses need to give a considerable percentage of their companies to raise enough funding for projects and operations. Therefore, equity investors take their share of the profits if the company continues to grow and becomes successful.

You must wondering which is the best way for businesses to finance their companies: debt or equity? All companies do a combination of both! Business management goal is to minimize the Weighted Average Cost of Capital. Below is the formula for WACC. This is an analysis tool used by companies to decide how much their company is spending to propel growth and profitability.

Unless you’re living under a rock, you heard Congress passed the Tax Cuts and Jobs Acts last year. As always, there are boos and yays for any bill our congressmen and congresswomen pass. Whatever your opinion is about the new tax bill, most popular part of the act was tax cuts!

Let me refresh your memory, so you can remember the specifics about the tax cuts. The Republican controlled Congress has simplified the income-tax code, which affects nearly every working American. The Tax Cuts and Jobs Acts suggests the current seven individual tax brackets into only four. These new tax brackets have new rates and thresholds for where higher taxes kick in. From the image below, the new bottom tax rate covers more income than the current 10% and 15% brackets do. As a result, the GOP is striving to lower taxes for many middle-class households. However, the wealthy are expected to face same tax rate, so their income tax will be unaffected by the newly proposed tax plan.

The Tax Cuts and Jobs Act also projects to lower taxes for various businesses. The Republican lawmakers plan to reduce corporate tax rates from ridiculously high 35% to 20%. This is huge for the United States as multinational corporations will keep more jobs in the country instead of outsourcing to developing nations for cheaper labor. The corporate tax code also includes 30% deductibility of cash flows, immediate deductibility in capital investments and removal of taxes on active foreign profits. If the bill becomes successful, the United States could enforce one of the lowest corporate tax policy in major developed nations.

President Trump wasn’t lying about the America First policy as he came with fire and fury. He introduced several tariffs hoping to bolster domestic production, while hoping to reduce imports and international reliance.

Before I ramble about how politics will affect our economy, let me first explain what a tariff is. A tariff is a tax or duty imposed on imported goods and services. Imports are considered bringing goods and services from abroad into your country for sale.

Governments impose tariffs to raise revenue or to protect domestic industries from foreign competition. The goal is to make foreign-produced products more expensive, which attractively portrays domestic goods and services to consumers.

There are primarily two different types of tariffs: protective tariff and revenue tariff. The main purpose of a protective tariff is preventing foreign companies selling products in the domestic country. These tariffs have extremely high tax rates, which foreign countries don’t even considering selling to.

On the other hand, revenue tariffs want to raise money for the government. Think of this as a tax on gas, alcohol, or cigarettes. The government taxes these products because they know customers will purchase these goods despite the increase in price in these goods. As a result, consumers still get their products, the government makes some money.

Wow tariffs sounds so great! Unfortunately, they are not as pleasant as they sound theoretically. Unintended side-effects can actually hurt the domestic economy. For instance, domestic industries become less efficient and less innovative due to reduced competition. Furthermore, the domestic industries can become a monopoly, which tends to push up prices and reduces supply. Additionally, other nations can retaliate your economic policy by imposing their very own tariff. Consequently, this leads to a trade war, which is no bueno for either country.

Now we a good foundation about tariffs, let’s discuss how Trump’s policy will affect the economy and business behavior. One of the newly introduced US tariffs is imposed on washing machines. The regulation applies a 20% tax on the first 1.2 million imported residential washers in the first year then 50% for additional imports.

Yikes! That is brutal for foreign competitors.

However, foreign manufacturers are figuring out solutions to bypass this expensive tariff. For instance, few companies proclaim they could incur the additional costs and still post major profits for their business. Other companies exported millions of washing machines years before the policy became enacted because they feared Trump’s America First. The last popular decision was construct a manufacturing plant in the United States, so they would not have to worry about the tariff at all.

Ultimately, we have to wait until the future to understand the true impact of this tariff.

President Trump’s State of the Union captured the attention of everyone this week. Trump took full advantage of this mandatory, yearly speech by establishing his budget, nation’s economic report, and outlining his legislative agenda. He hit on key topics, such as immigration, North Korea, and Guantanamo Bay. However the one subject matter that grasped the nerdy minds of all economists: INFRASTRUCTURE.

Donald Trump emphasized massive infrastructure spending a top priority for the upcoming year. He plans to pledge $1.5 Trillion to revamp the nation’s organizational structures and facilities.

Yes, you read that right. Trillion with a huge capital T. This plan is extremely essential for a strong foundation of the entire nation.

Infrastructure is one of few things both Republicans and Democrats have planned on their agenda. The debate on this issue is going to be how to fund the infrastructure bill, how much money to allocate for the infrastructure bill, and highlighting which cities and highways grasping the most money from the infrastructure bill.

You must be wondering why infrastructure is so important to the economy.

Public infrastructure investment is one of most common fiscal policies used by the government to fight recessions. The government stimulus spending is the classic Keynesian economics philosophy. Keynesian economics is a popular economic theory of total spending in the economy increases GDP output and inflation.

Coming back from the small tangent, the $1.5 Trillion infrastructure package creates new projects. Therefore, the new projects employees more people and creates more businesses for industrial companies.

Additionally, the increased employment leads to more citizens with more disposable income. As a result, the economy becomes more stimulated, since consumers will be spending more in the market. Consequently, businesses will make more revenues, which leads to more business prosperity.

As a good as this sounds, there are many critics of this plan. Since the United States economy is not in a recession, few economists believe the additional economic stimulus might lead to overheating in the economy. This can lead to overly excessive increase in inflation. Therefore, consumers will be buying goods at outrageous prices. Also, businesses will have to cut production, since input costs escalated.

All in all, despite all the economic controversy, America will finally get stable highways and smooth public roads.

If you’re an economic nerd like me, you definitely have been following the World Economic Forum in Davos, Switzerland this week. This is the most brilliant time of the year as 2,500 of the world’s top business leaders, international politicians, economists, celebrities, and journalists meet for four day to discuss the most pressing issues. The World Economic Forum’s mission is “committed to improving the state of the world by engaging business, political, academic, and other leaders of society to shape global, regional, and industry agendas.”

The World Economic Forum invited two colorful, special guests to speak: United States President Donald Trump and his sidekick US Secretary of the Treasury Steven Mnuchin. Like usual, Trump said some questionable comments, such as the US economy is asserting to have a weaker US Dollar. Alright, yeah this wasn’t as controversial as him calling other nations “shith*les” or claiming the United States has a bigger nuke button than North Korea.

However, Trump is sending mixed signals to the world by promoting two contradicting economic policies. The Trump Administration has delivered on their America First agenda, which promotes American businesses and tariffs on foreign products. As a result, the US would be shying away from trade as domestic goods are cheaper. The overall goal of America First was to boost growth in the economy. However, a weak US Dollar would make imports more expensive as the purchasing power decreases. No nation in today’s modern world is self sustainable. Therefore, even if the US encourages more manufacturing and production, they would still be required import resources that produce the goods. Therefore, American final goods would actually be more expensive.

Yeah, this is very confusing. This is basically your girlfriend telling you she wants nothing for her birthday, but she keeps showing you pictures and magazines of the latest clothes dropping from Chanel and Victoria Beckham.

If you’re lost in topic, do not worry I am going to explain the fundamentals behind weak currencies.

The meaning of a weak dollar is the US Dollar’s value is decreasing relative to other foreign currencies. Consequently, the purchasing power falls, which makes consumers pay more for imported products and traveling. However, it allows the American economy to compete in the global markets. The weaker dollar allows American exports to be cheaper, so more nations would buy our goods and services. Additionally, tourism would rack in more revenue as more foreigners take more vacations in the United States as it is less expensive.

All in all, if your family is planning a trip, you better postpone it or pay a boat loads of more money.