Asset Classes

Assets Classes are "a group of marketable financial assets that have similar financial characteristics and behave similarly in the marketplace". They represent the different types of (usually) tangible things that can be owned and be assessed a "valuation".

Public Stocks (Equities) - shares of ownership in publicly-held companies 

• Stocks are listed on stock exchanges which are open to the public investment
• Historically, have outperformed other investments over long periods
• Most volatile in the short term
• Returns and principal for a stock fluctuate over time, making funds from the eventual sale of the stock worth more or less than original cost (depends on the stock purchase price)

Private Equity (Private Stocks) - shares of ownership in privately-held and unlisted companies

• Typically, only a few large investors
• Usually focuses on short-term capital extraction and "sale for parts"
• Often financed by leveraged buyouts (loading the target company with new debt to help the PE firm fund the acquisition of the target company)
• Can be designed to turn around the fortunes/profitability of a distressed company by cutting costs, replacing management and changing company direction; in this case the investment is more long-term, but ultimately the goal of PE is to extract a large profit from the sale of the acquired company once its profitability (and thus valuation) has improved
• A "property flip" is a minor/small-scale form of PE

Bonds/Notes/Bills (Fixed Income) - guaranteed bond investments

• Pays a set rate of interest over a given period, then return the investor's principal
• More stability than stocks
• Value fluctuates due to current interest and inflation rates
• Includes "guaranteed" or "risk-free" assets
• Also includes money market instruments (short-term fixed income investments)
• Often comprised of federal government or municipal bonds, notes or bills
• Can also include corporate loans
• The term used to describe this type of debt asset ("bond/note/bill") depends on the length of the debt instrument maturity, with "bonds" typically being a maturity of 10-20 years, "notes" being a maturity of 1-10 years and "bills" (like T-Bills) being a maturity of less than 1 year

Cash and Equivalents (Liquid Assets) - assets that can be quickly and easily converted into immediately usable currency without losing significant value

• Checking and savings accounts
• Certificates of deposit (CDs)
• Money market funds
• Treasury bills
• Treasury notes
• Commercial paper
• Foreign currencies which are easily convertible to the currency you need to transact in
• Liquid assets have the advantage of giving their owner the power to buy things without incurring any debt

Cryptocurrency - a "piece" of (usually limited) digital currency

• The backbone of "DeFi" or Decentralized Finance
• "Digital rare earth material"
• Relatively accessible; mineable and tradable
• "Risk-on" asset; lacks regulation, ESG concerns, highly volatile
• Liquidity has increased with institutional adoption
• Supply varies, some are finite or even designed to shrink in supply and thus deflationary
• No inherent value or utility (like NFTs)
• But(!), cryptocurrency underlies the transactional architecture of a bulk of all untraced, "black market" commercial activity worldwide
• Barring meaningful cryptocurrency regulation, its value is unlikely to ever "go to zero" or not hold some significant value because of its usefulness in facilitating illegal monetary transactions and digital money laundering

Recently, interest in stocks and crypto has spiked while interest in bonds and private equity has remained more muted and stable

Real Estate - investment property (houses, stores, factories, land lots, etc.) and commercial real estate investments

• Helps protect future purchasing power as property values typically rise with inflation
• Values tend to rise and fall more slowly than stock and bond prices.
• It is important to keep in mind that the real estate sector is subject to various risks, including fluctuation in underlying property values, interest rates (which directly influence mortgage rates, which usually compose a large part of any real estate purchase), eminent domain law, and potential environmental liabilities
• Can include "Infrastructure as an asset class"- a broad category including highways, airports, rail networks, energy generation (utilities), energy storage and distribution (gas mains, pipelines etc.)
• Can provide a long-term cash flow, a hedge against inflation, and diversification (low correlation with the top two traditional asset classes: equity and fixed income)

Commodities - physical goods such as gold, copper, crude oil, natural gas, wheat, corn and electricity

• Can serve both as a value store in and of itself (in the case of things that don't expire, like precious metals) and as raw material for the construction and delivery of downstream physical goods and services
• Helps protect future purchasing power as commodity values rise with inflation
• Values tend to have low correlation with stock and bond prices
• Price dynamics are unique: commodities become more volatile as prices rise

Interest in CRE and commodities has fallen precipitously since 2004...

References:

https://www.thrivent.com/insights/investing/an-investors-guide-to-asset-classes-types-allocations-more

https://www.poems.com.sg/glossary/investment/asset-class/

https://cointelegraph.com/learn/overview-of-different-types-of-asset-classes

https://en.wikipedia.org/wiki/Asset_classes

What is the Fed?

The Fed

The Federal Reserve, also known as the "Fed", "lender of last resort" and a "bank to other banks" is the central bank of the United States that determines U.S. monetary policy. This means that it controls the national money supply which enables it to control national interest rates. This is used to keep two major indicators in check- unemployment and inflation. The Fed also provides short term loans (a kind of "stimulus") to banks in times of stress.

History

For a long time, people feared central banks had too much power in too few hands. However, in 1907, the Knickerbocker Trust Co. went bankrupt which led to a run on the banks and the banks didn't have sufficient cash reserves to give customers their requested withdrawals. To quell the panic, J.P. Morgan and other private wealthy American individuals made loans to the banks to get past the crisis. It was at this point the need for a central banking authority was made clear to America.

What the Federal Reserve does

The United States developed the Fed as a way to keep the economy healthy and provide reserves when necessary to prevent panic. It is a tool, most notably in its control of the federal funds rate.

The Fed controls this "root" lending rate (or the rate which the Fed lends to banks) and this directly influences the rate at which banks lend to each other and ultimately, the rate trickles down to companies and individuals. This is what is referred to as "the Fed changing the interest rate".

• Higher rates to cool a hot economy lead to more saving, less spending- a contraction of the money supply. Prices fall, lowered inflation.

• Lower rates to stimulate a flagging economy lead to more spending, borrowing and investing- an expansion of the money supply. Prices rise, heightened inflation.

The Fed raises interest rates to check inflation and lowers rates to check stagflation. The Fed is essentially designed to keep money flowing and prevent any major disruptions in our economy. The goal is to keep the U.S. economy healthy.

To match its target, the Fed performs "open market operations" which traditionally is the buying and selling of short-term U.S. government securities. To fight more recent financial straights however, the Fed has resorted to buying and selling more long-term, non-governmental securities.

The Fed essentially performs a balancing act to ensure that there is always enough buyers and sellers or put another way, they ensure that too many dollars in circulation for too few people (specifically people spending cash/money) doesn't lead to runaway inflation and that too few dollars in too many hands doesn't lead to Recession or a tightening of overall lending that causes the economy stagnate or crash.

The Federal Reserve building in Washington D.C.

Fed criticism

The Infamous Fed Chairman Ben Bernanke line during the 2008 Financial Crisis "using a computer to mark up the size of the account" 👀 is not a typo or misquote. It is however, very misinterpreted by many. In normal times the Fed doesn't need to literally expand the money supply very often by printing dollars- it merely purchases securities with dollars to put those dollars back into circulation.

But when it is determined that the Fed doesn't have enough dollars to buy the securities required to stabilize the banking system it has to (heaven forbid) create dollars to match the need for lending during a lending freeze as was seen in the Financial Crisis of 2008, 2009 and Spring of 2020 when COVID-19 first ravaged the American economy. If you think about it rationally, the United States usually increases overall productivity year-over-year. With this increase in productivity, and increase in securities valuations, you need the physical dollars (or other tangible liquid assets like precious metals) behind the increased productivity and valuations otherwise when there is an adverse event and people go running to withdrawal money and liquidate their securities, there will not be enough money.

Printing dollars is necessary because our economic systems, and specifically the "cash paper/note" is man-made. And it cannot expand without human action (unless we put the economic into some kind of smart contract, but I'd advise against that).

If you expand the overall wealth in the U.S. by 3% or 5%, should the money supply not also expand to reflect this expansion?

If it doesn't, then $1 in current USD value would probably be worth about $3,378 dollars. It makes small transactions impractical. And I suppose we could instead print more "coins" but coins are more expensive to make and they are heavier.

The need for the Fed

There will never be enough money to autopilot the U.S. economy or obviate the need for the Fed and its independency. There will always be a need to do the balancing act of adjusting interest rates, the printing of money to match productivity and lending needs and the extreme rescue measure of printing money to create extremely large loans in order to keep key so-called "too big too fail" institutions solvent.

And that is to be expected. All of this is due to human nature and the fear instinct. When things go really bad (usually due to lack of regulatory oversight and/or financial fraud), people are going to run to the bank for cash and attempt to liquidate securities. And when peoples' and companies' bank and IRA balances are tied to institutions that evaporate overnight, the FDIC can't help beyond $100,000 per account. For companies and individuals with very high balances, you cannot expect the bank to have all the cash on hand to match everyone's balance (to say nothing of the ability to liquidate any of the myriad securities banks now offer to customers).

Banks are in the lending business, not the saving business. And there is a general expectation that there won't be a run on the bank and that all customers will not run to liquidate long-term assets all at once. So when these kinds of things happen (or when things start to tip in that direction)- the Fed steps in to provide everyone their "tomorrow money", today.

This act and the act of controlling the interest rates lever may not look very fair but it is necessary to rescue the economy in times of a major adverse event and to counter economic booms and busts and limit inflation.

When the next financial crash occurs, I'm not counting on Elon Musk and Bill Gates to be as generous as J.P. Morgan.

References:

https://www.youtube.com/watch?v=M7nj2X-yl_U

https://www.youtube.com/watch?v=qoUmSer2IxA

https://www.nytimes.com/2020/03/21/opinion/-coronavirus-stimulus-trillion.html

Corporate Common Stock, Corporate Notes (Bonds), Treasury Bonds, Municipal Bonds and other Securities

All of these financial instruments are essentially different templates for an agreement on the terms of financing deals.

There is a tendency for bonds and stocks to have an inverse yield (earned interest) relationship

A bond purchase/sale is an agreement between the bondholder (creditor) and the bond issuer (debtor) for the distribution of capital to the debtor which will then be repaid (with interest normally) to the creditor in a certain increment of time (2-yr, 10yr, 30-yr, etc.).

A Treasury bond is issued by the U.S. Treasury and backed by the "U.S. Government's full faith and credit". The same holds for foreign state bonds. Municipal bonds are for state, city and other localities. Government agencies issue bonds as well and these are generally regarded as very safe investments because of the high degree of regulation of the creation and sale of these bonds.

There is more to bond markets than just T-bills

A stock purchase/sale is an agreement to own a portion of a company. So companies with outstanding stock or who decide to offer stock for the first time (IPO or "Initial Public Offering") are turning to John Q. Public for needed financing.

Keep in mind corporate stock is not the same as corporate bonds/notes*

In return for the financing, the stockholder receives dividend payments and the ability to earn a profit by selling the stock if its price rises above the original purchase price. Stocks split the company up into “shares”. As a corporation has no individual owner (by design), corporations make natural stock issuers.

Corporate or Private Common Stock is riskier than government-backed bonds due to higher corporate default rates and being less liquid (less quickly convertible to cash). Unlike bonds which expire, stockholders may choose to hold onto stock indefinitely.

Treasury bonds are safer and tend to offer less return; but over time in the U.S., they have been reliable (no defaults)

Key distinction: Stocks offer an ownership stake in a company, while bonds are akin to loans made to a company.

As seen here patience and a successful company can lead to total returns of over 1500%: https://www.cnbc.com/2017/11/28/if-you-put-1000-in-amazon-10-years-ago-heres-what-youd-have-now.html

And imagine if you would have just invested that nest egg money in Netflix back in 2008? 😉

Corporate Note ($5) for The Johnson Company

*Corporate notes are simply corporate bonds; some financial sources assert an ambiguous and inconsistent distinction (that corp bonds have a shorter maturity, that they are issued differently) but essentially, they are the same thing.