How I’m Profiting From A Lack Of Worry
Recently, I realized almost everyone I talk to expects tomorrow to look a lot like today.
As an investor, that’s a sign I like to see.
People generally seem to believe their jobs are safe. They’re planning for major purchases because they assume prices will hold relatively steady. In other words, consumer confidence is high and steady. This anecdotal evidence is also confirmed in the economic data I review.
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Consumer and investor expectations are important to investors. It might be easiest to see in the stock market. If investors expect stock prices to go up, they buy and hold stocks. When they expect a significant decline, they sell stocks and hold cash. These actions explain long-term bull and bear markets.
For consumers, expectations can be even more important. If we expect prices to increase, we will buy sooner rather than later. Expectations for lower prices can lead to delaying purchasing.
Some retailers, for example, train consumers to wait for sales. I’ll never pay full price for a large item at Bed, Bath & Beyond because I know they will send me a coupon for 20% one item within the next week. This might seem like a small example of consumer expectations, but it can explain a great deal about economic data.
When Confidence Goes Wrong
Venezuela is in the midst of an economic collapse of unimaginably tragic proportions. The New York Times recently noted:
By year’s end, Venezuela’s gross domestic product will have shrunk by 62 percent since the beginning of the recession in 2013.
Venezuela has lost a tenth of its population in the past two years as people fled, even trekking across mountains, setting off Latin America’s biggest ever refugee crisis.
Venezuela’s hyperinflation, expected to reach 10 million percent this year according to the I.M.F., is on track to become the longest period of runaway price rises since that in the Democratic Republic of Congo in the 1990s.
Inflation like that means consumers want to hold cash for the shortest amount of time possible. If a butcher sells hamburger for cash, by the time he buys something with that cash it will have lost a significant amount of its value.
In the United States, there is no rush to spend cash. That means inflation is low and expectations for inflation are low.
This is an important indicator to follow. And the data shows there is no reason to expect any changes in the outlook for inflation.
One of the indicators I monitor is the velocity of money. That’s in a downtrend right now, but it might be bottoming, as the chart below shows.
Source: Federal Reserve Bank of St. Louis
Velocity of money measures how many times a dollar is spent in the economy. It’s an important indicator for a number of reasons, including that it serves as a leading indicator of inflation.
In the 1970s, as inflation increased, so did velocity. Consumers needing a new car or a large appliance tried to buy as soon as they could to avoid the price increases that would come every few months. It can look like economic growth since GDP can be measured as the product of velocity and the money supply. But higher velocity can reveal concerns about inflation, and inflation does tend to follow expectations. That’s why I follow this indicator, and many others, and for now see no reason to worry.
How I’m Trading In This Environment
That lack of worry, which carries over into many aspects of the economy, can provide a number of investment opportunities. An interesting example of the lack of worry can be seen in The Williams Companies (NYSE: WMB).
Williams was in the news recently. According to The New York Times,
New York regulators on Wednesday rejected the construction of a heavily disputed, nearly $1 billion natural gas pipeline, even as business leaders and energy companies warned that the decision could devastate the state’s economy and bring a gas moratorium to New York City and Long Island.
The pipeline was planned to run 37 miles, connecting natural gas fields in Pennsylvania to New Jersey and New York. Its operator, the Oklahoma-based Williams Companies, pitched it as a crucial addition to the region’s energy infrastructure, one that would deliver enough fuel to satisfy New York’s booming energy needs and stave off a looming shortage.
Regulators seem unworried about the supply of natural gas even as utility companies imposed a moratorium on new gas hookups in Westchester County (a suburb of New York City) and warned of a moratorium in New York City and Long Island if the pipeline is not approved.
This all points to higher prices for natural gas in the region — and more profits for the companies providing gas to New York.
Market action in the stock indicates investors have been waiting for this decision, and the stock has been in a trading range for nearly three years.
At current prices, the stock is undervalued with a dividend yield of about 5.4%. Over the past seven years, the yield has averaged 4.8%. In the long run, fundamental metrics like the dividend yield tend to be mean reverting, which means we should expect the yield to move back toward its average — which would imply upside of about 17%.
An Even Better Way To Trade
Now, traders could simply buy shares of WMB, wait for the upside, and collect the dividend… But over at Maximum Income, we have a better plan.
WMB is the ideal stock for a covered call strategy.
#-ad_banner-#For those who are unfamiliar, this is a strategy involving options — but don’t let that scare you. It’s much safer than some of the “risky” options trading strategies you may have heard about. IN fact, quite the opposite — it’s regularly used by professional money managers to safeguard their clients’ wealth and make extra income.
Here’s how I explain covered calls to new readers over at Maximum Income…
A call option is simply the right — but not the obligation — to buy a stock at a specified price before a specified date. Selling a covered call obligates us to sell that stock to the call buyer if it moves above a specified price (known as the “strike price”). When we accept that obligation, we receive a “premium” upfront almost instantly.
Since that premium is ours to keep no matter what, we like to think of it as a “bonus” dividend.
Now, you can be asked to sell the stock at any time between the moment you collect the premium and the expiration of the option contract. To minimize risk, my readers and I only sell calls on stocks that we own 100 shares of — that’s what makes it a “covered” call.
In the case of WMB, thanks to our strategy, one of two things will happen… If the stock rises to our strike price ($28), we’ll sell the shares we own for a tidy 5.2% profit in 25 days (that’s factoring in the premium, the regular dividend, and the share price appreciation).
If it doesn’t, then we will have earned 2% on our trade in only 25 days (the premium plus the regular dividend). And since we still own the stock, we can repeat this process again and again…
You Can Make Trades Like This, Too
There’s a lot more to say about this strategy, but I simply don’t have the space to cover everything today. But suffice it to say, it’s about as close as you’re going to get to a win-win when it comes to investing.
We’ll be happy either way. That’s why thousands of investors have joined me over at Maximum Income. They’re not content to simply accept the income offered by traditional stocks and bonds. If you’d like to know more about how covered calls work, and how you can use it to generate hundreds — even thousands — of dollars per month, no matter whether the stock market is moving up, down or sideways — simply go here.