Is it a Glossary? A Tutorial? A Crash Course?
Have you ever found yourself reading a newsletter that contained a bunch of jargon and acronyms that read like a foreign language? Surely, we are not talking about a Monarch newsletter here; we’re just asking for a friend. When faced with unfamiliar content, do you try to guess the meaning based on context? Do you google it? Do you breezily skip past it? Or is that your “out” to give up on the newsletter entirely?
Maybe we can serve as your ally when it comes to financial terms. I admit this is a poorly-disguised sleight of hand intended to make you think of us as altruistic, and not the source of the problem. But seriously, you could keep this letter, like a dictionary, wherever you tend to read Monarch, I mean, financial press. Maybe that’s the bedroom nightstand, maybe a cozy nook, maybe the fireplace, beside it that is. If that’s asking too much, you might at least glean something here you can use to dazzle your friends, especially those who aren’t Monarch clients.
But first I need to retrieve my fellow Monarchians Dave, George, and Adam, from under the bus. They do a much better job of explaining things when they write. So either this is my mea culpa or I’m trying to demonstrate commitment to doing better. I’m reminded of a newsletter we once wrote, where we unveiled our own search engine, and were optimistic that people would no longer google investment-related questions, but they would “Monarch” them. That didn’t exactly catch on, perhaps because said Monarch search engine was as real as the band Spinal Tap. We have higher hopes for this endeavor. You might think, “this sounds like as much fun as watching paint dry,” and that is absolutely our intention, to set the bar as low as humanly possible. Without further ado, finance expertise awaits you!
Bonds
Yikes, no lightweights to get the ball rolling. To understand bonds is to understand investing. At its core, owning a bond gives you a claim on the assets of the issuer of the bond, whether the U.S. Treasury, a company, or a municipality. Bond investors want to be assured they will get their money back at maturity of the bond, and they demand some “interest” to compensate them for giving up their cash, and for the risk they won’t get it back in full. So, the decision on whether to buy a bond starts with gauging the probability of getting one’s money back, and then on whether the rate of interest is fair. The rate of interest is also known as the bond’s “yield,” which we will dive into next. The amount of interest that a bond pays is also called the “coupon.”
Yield
Yield is the amount of income you expect to receive, as a percent of how much money you have invested in something. This income can take the form of interest, in the case of a bond, bank savings account, or CD. Or it is in the form of dividends in the case of stocks. It can also have the form of distributions, in the case of partnerships and mutual funds.
If a stock currently trades at $100 and it pays a dividend of $3 annually, the yield is 3%. It does not matter how much you paid for the stock; yield is based on the current price. Bond yield is trickier, since there is a maturity date to reckon with. If you ever see the term “current yield,” it is simply the annual interest (or coupon) divided by the current price. If a bond pays a 2% coupon and the bond price is $90, the current yield is 2.2% (2% * 100/90). To bond investors, this is a meaningless statistic, because it ignores the fact that they will earn $10 more between now and maturity, because bonds mature at $100 (also known as “par value”). If this bond matures in 5 years, bondholders will receive a bonus of ~$2 “accretion” per year from $90 to $100. On the base of $90, that works out to another 2.2% of yield. Thus, the “yield to maturity” is 4.4%. That is your expected return from buying this bond at $90 and holding to maturity.
When evaluating yield of various investments, investors must first decide how much yield matters to them. In assessing bonds vis a vis stocks, they need compensation for the fact that bonds don’t generate “capital appreciation.” [Fun fact: bond accretion up to par is considered interest.] Also considered are the volatility of each—stock prices fly around much more than bond prices, and the potential for losing money is much greater for stocks. “Liquidity” also is considered—if you want access to your funds, how quickly is quick enough, and do you want assurance of getting your full investment back with no loss? Bond and stock trades now “settle” in 1 day, meaning if you sell either security today, you will have the funds as cash in your account tomorrow.
As for “full value,” bond prices can fall, so you can lose money owning a bond and selling it before maturity. If you hold to maturity, you will get the yield to maturity you signed up for when you bought it. Granted, a lot of European and Japanese bonds had negative yields throughout the 2010s; buying them assured you of losing money. If you have cash in a checking or savings account, or in a “money market fund,” these do not have a maturity, so the yield on them is not locked in. You can put money in when rates are 4%, but if rates fall to 1%, you’ll be getting 1% then. See chart, money market fund yields since 2000:
A money market fund holds very short-term bonds, generally exclusively issued by the US federal government, so, very safe. If the fund “sweeps,” that means all your cash is in the fund and the price never wavers from par. If it does not sweep, the price can fluctuate. This is an issue now with Schwab and soon at Pershing; their sweep money market fund yields almost nothing. We can buy an ultra-short term bond fund that holds the same 3-6 month treasury bills, with a respectable yield (actually better than the old money market fund’s yield). The only downside is that the price can fluctuate, though typically very little.
Fed Funds Rate
While we’re on the subject of interest rates, the “Fed Funds Rate” is the one rate that the Fed more-or-less controls. The Fed does not control interest rates of longer treasury bonds, such as the 10-year bond; these are set in the marketplace. When you buy the 10-year treasury at a certain yield, you are tacitly agreeing that the yield is acceptable. When the government issues debt at that yield, the Treasury finds that yield acceptable as well, although they issue so much debt that they don’t have a choice, other than…to issue shorter-term “t-bills” if they are going to cost the Treasury less interest. In case you were wondering why Trump routinely threatens Fed governors to lower Fed Funds rates.
If the Fed cannot control interest rates beyond the Fed Funds rate, can they at least affect them? The short answer is yes, but only if the market complies. During the Financial Crisis, the Fed lowered the Fed Funds rate to 0%, and when that didn’t seem like enough “monetary stimulus,” they started buying trillions of long treasury bonds AND mortgages. When demand for something goes up, the price goes up. When a bond’s price rises, its yield drops. [Same for stocks, by the way.]
Yes, we just waded into the bond price-yield flytrap, willfully, because we are here for learning, Dear Reader. Think back to that 5-year bond we discussed on the first page, priced at $90, with a yield to maturity of 4.4%. Now let’s say after 1 year, the price has risen all the way to $100. Remember the coupon is only 2%. So what is the yield to maturity then? That’s right, only 2%–just the coupon. As you see, price and yield travel inversely. By the way, that is a huge drop in yield for 1 year, from 4.4% to 2.0%. Why would the bond’s yield fall that much? Almost certainly, comparative yields on other bonds also fell by that much. It’s a competitive market in Bondland. If the “prevailing yield” in the market for similar bonds was still 4.4%, nobody in their right mind would buy your bond at 2% yield.
For yields to fall by that much in one year, there’s probably a recession going on. But good news to you if you bought that bond a year ago at $90, because your “total return” for that one year on that bond was +13.3%! That is the price appreciation ($10) plus the coupon ($2), divided by the original price ($90). That +13.3% total return might really shine if the recession has laid waste to stock prices. By owning bonds alongside stocks, you actualized “asset class diversification,” and it also provided you with something to sell, if your “distribution rate” (the % of your total investments you take out each year to fund your life) requires you to be selling assets because the rate is above your overall portfolio yield. This is called “principal invasion,” calculated as your distribution rate minus your yield. That fantastic bond return could also come in handy, to sell it and buy cheap stocks, known as “rebalancing.”
Enough with bonds, when can we get into something more exciting? Is this voice in my head or coming from a stock-crazy mafia? Anyway, let’s do that.
P/E Ratio
Most investors will recognize this as the Price of a stock divided by Earnings generated by the company associated with that stock. Simple enough. But what earnings? You can look at “trailing” earnings (the last 4 reported quarters), also known as “TTM” (trailing 12 months). Those earnings are real, in the bag. Or you could look at “forward” earnings (estimated earnings for the next 4 quarters), or “FTM” or “F4Q” (forward 4 quarters). Presuming earnings are expected to grow, using forward earnings will get you a lower P/E. The problem is that there’s no guarantee these earnings will come to pass, as these are merely estimates made by analysts. The “earnings” used in these numbers are after-tax net income per outstanding shares. You could also choose to focus on other earnings measures, which usually means you are adding back certain kinds of expenses, like stock-based compensation or goodwill amortization. The many forms of earnings serve to obfuscate what are real earnings.
CAGR
This is one of those cool acronyms that stands for something (Cumulative Average Growth Rate), AND you can say it like a word. Go ahead. It’s pronounced like “kegger” (which is not a financial term). This is the average “annualized” growth rate over a period longer than one year. We dove head-first into the subject of “expected return” (the annual total return you expect your money to earn) at our seminar last December; if you want to see this in more detail, please visit “The Library” on our website. Adam unveiled jaw-dropping statistics on market returns since Eisenhower took office in 1953. He broke down returns based on when a Republican sat in the Oval Office and when a Democrat did, and total for all presidential terms. So as to drive traffic to our website, I will force you to go to The Library page to find the 2024 Winter Seminar recap. You will not regret it.
I can divulge to you that the CAGR total return for the S&P 500 since then is +11.1%. This is slightly ahead of the long-term total return for the market of +10% or so, since 1926. You might be thinking the total return of the market in 1926-1953 must’ve been quite a bit below +10%, because it represents only roughly ¼ of the 1926-2025 period. If so, you are an official data wonk! This did include the Great Depression, to be fair.
Anyway, the point is that +11.1% annual return compounded over 72 years equates to a total “cumulative” return of +195,520%. $1,000 invested one time on 1/1/53 would now be worth $272,000 today. But if you reinvested all the dividends you received, rather than spending them, you would have $1.95 million. “The power of compounding” is powerful indeed.
Cap Weight
Speaking of the S&P 500, it is a “cap-weighted” index, with cap short for market capitalization. The “market cap” of a stock is its price multiplied by the number of shares outstanding. This is one gauge of the size, or prominence, of a company. Unlike assets or sales of the company, market cap represents what the market believes a company is worth. Most indexes, like the S&P, the Mid-Cap 600, the Russell 2000, or the MSCI global indices, are cap weighted. This makes sense to the extent that very large companies should matter more to an index than the smallest company in the index.
We are living in an era of historically out-of-bounds “heavy” weightings for the largest companies. As this chart shows, the largest 10 in the S&P 500 now represent a 36.2% weighting in the index. This is more than 10% higher than it has ever been, including the peak of the dot.com boom:
[Author steps onto his soapbox.] The pervasive narrative is that today’s largest tech companies are unassailable, with large market shares in huge and growing businesses, tons of cash flow, low cash needs, and huge “moats.” All true. A moat, like that surrounding a medieval castle, keeps would-be invaders on the other side of the moat. A moat can be small enough that one could long jump over it, or it could be a mile wide, filled with sharks. The market currently ascribes huge moats to the biggest tech companies, simply because their moats have long been huge, and earnings continue to grow strongly. Can moats dry up?
Enter the S&P 500 “Equal-Weight” index. This is the same 500 companies, but all weighted equally at 0.2%, rebalanced every day. Apple and BorgWarner….equal importance. Before you start laughing at the notion that this makes any sense, humor me one question: why has the Equal Weight S&P 500 index outperformed the regular (cap-weighted) S&P 500 over the long-term….including the last 10 years when the cap-weighted has significantly outperformed the Equal Weight? Crazy as it sounds, even including the last 10 years, since 2000, Equal Weight has outperformed by 1.6% annually.
Is the preeminent narrative wrong, or right for a season, or both? Yes. As long as growth continues to be superior and moats continue to be wide, and there is nothing on the horizon that looks like it will dent either premise, these exorbitant weightings can remain. There are already some chinks in the armor, though, in that most of them are now seeing declining free cash flow, as their capital spending increases exponentially. Competition among them is also increasing, as they all seek growth in new adjacent businesses. If you look back at history, you will find the problem with the megacaps is that they were valued as if their moats would never shrink, and their moats did shrink, which hurt pricing power and thus earnings, and thus valuation (see: P/E ratio).
GDP
“GDP,” or Gross Domestic Product, commonly refers to the size of the economy. Most usage of GDP refers to how fast the economy is growing. GDP is the sum of all “personal consumption,” (consumer spending) in the U.S., all federal, state, and local government spending, all business capital spending, the change in business inventories, the change in residential spending (on houses), and the change in “net exports,” or exports minus imports. Personal consumption comprises over 2/3 of GDP, at 68%. The total size of the U.S. economy is just over $30 trillion now.
GDP is the amount of goods and services produced inside the U.S. If an American company produces goods outside the U.S. and imports them to be sold here, they do not count. If you want to know how much stuff is consumed in the U.S., “Final Sales” is your data series of choice. It is most interesting to look at Final Sales growth, to gauge demand by Americans. Inventories and foreign trade can distort the GDP picture, especially when a sudden change has taken place, like the April tariff implementation. Companies imported hundreds of billions of product in the first quarter, in advance of the tariffs, so this would be considered an import without being consumed, so it gets subtracted from growth. Thus, “real GDP growth” (after inflation is subtracted) was -0.6% in Q1, but rebounded sharply to +3.8% in Q2. But final sales were smoother: +1.9% in Q1 and +2.9% in Q2…no recession here.
GDP growth can be reported as “YOY” (year-over-year, or this quarter versus the same quarter last year) or “QOQ” (quarter-over-quarter, meaning this quarter versus the immediately preceding quarter, like Q2 vs Q1). Growth rates are annualized; in the case of YOY growth, it is already annualized since the comparison period is 1 year prior. But for QOQ, the growth takes place only over 3 months, so its growth rate is annualized by multiplying it by 4, which is technically called “SAAR” (Seasonally Adjusted Average Rate). Yes, some data series get adjusted for seasons because the economy naturally picks up more in the summer than in the winter due to, for example, construction.
Finally, “nominal GDP growth” includes the effect of inflation, whereas “real GDP growth” backs it out. In 2024, nominal GDP growth was +4.9% and real GDP growth was +2.1%. Nominal growth reflects the growth in the dollar value of stuff bought/produced/sold. Real growth reflects the volume of stuff. Both can be useful.
If you’ve picked up on the fact that there are at least 6 different ways to slice and dice just one data series (GDP), plus all permutations of those 6, welcome to government statistics! As the saying goes, there’s lies, damn lies, and statistics. It’s remarkable that Americans come together to agree on stuff as much as we do, like using real GDP QOQ SAAR as the benchmark for economic growth.
Budget deficit vs national debt Neither of these is an acronym, but sometimes the two terms get conflated, so we want to clear up which is which. Budget deficit is the difference between how much the federal government takes in for revenues (taxes) in a year minus how much it spends. We last had a budget surplus in 2001, when we had the last vestiges of economic bipartisanship in Washington. As the chart below shows, the government typically runs larger deficits when the economy worsens (by virtue of rising unemployment), because tax revenues drop and safety net spending rises. The red line is the budget deficit as a % of GDP. The blue line is the unemployment rate (shown “inversed”). The red and blue lines travel close together. But these started to unmoor around 2015, as we have run higher deficits even with strong economies.
The budget deficit in the current fiscal year should end up at roughly $2 trillion, a tad worse than last year. Tariffs are included in revenues, meaning that the deficit would have been even higher without them.
The national debt is the accumulation of all those budget deficits that get “financed” by issuing treasury bonds. Yes, this newsletter is coming full circle! Total debt outstanding by the federal government is $37 trillion. That would be $2 trillion higher than last year, due to the $2 trillion budget deficit.
Laissez-Faire Economics
We have drifted into French economics history now? In a very strange twist of fate, this term indeed originated in the 18th century in France and is translated “let them do.” This was a movement of the people, with the Enlightenment well entrenched by then, that government should get out of the way and let people govern their lives. Adam Smith, the godfather of economics, took up the cause as Britain’s economy rapidly expanded in the 19th century, referring to the government’s role as the “invisible hand.”
The U.S. picked up the mantle and has been the torchbearer ever since, especially as Europe has socialized in the last 30 years, culminating in the ultimate in government oversight, the European Union. To be clear, capitalism is the American economic system of choice ever since the founding of our country, but within capitalism there are very different flavors, particularly regarding just how much the government should intervene. “Guardrails” are another way of saying that the free market should not be allowed to totally run the economy. We want workers to be safe, customers to not be scammed by nefarious businesses, and protections to be in place for the environment. The Fed is technically a guardrail for our financial system.
There has long been a distinction between our two political parties, in that Democrats typically favor more protection, more guardrails (and for its far-left wing, a complete abandonment of capitalism). Republicans have typically favored strong capitalism, with its far-right Libertarian wing posturing for no guardrails. We now have a strange situation in Washington, in that Trump favors more government involvement than we are accustomed to seeing from a Republican. Businesses have needed to adapt very quickly with a new playbook. Given that profits continue to rise this year, and the stock market is near an all-time high, we need to give a very high grade to corporate America for resilience.
Leading Economic Indicator Index (LEI)
We would be remiss if we didn’t throw Conference Board LEI into the mix. This is an index comprising 10 indicators which tend to lead, or happen early, and thus can be used to predict the economy: average weekly hours in manufacturing, average weekly initial claims for unemployment insurance, manufacturers’ new orders for consumer goods, ISM New Orders Index, manufacturers’ new orders for nondefense capital goods, building permits for new housing, S&P 500 Index, Leading Credit Index, interest rate spread, and average consumer expectations for business conditions.
Every sizable downturn in LEI, ever, has presaged a recession. A perfect record. In this cycle, LEI peaked in December, 2021 and has continued to decline ever since, hitting a new low in August. Among those 44 months, it has declined 39 months, and by a total amount that has exceeded every drop since 1960 except the Financial Crisis. Either this indicator is totally broken (“this time is different”), or we will yet have a recession in the next couple years. The route to avoid a recession is a narrow road. What is required: profits continue to grow (as companies extract labor cost savings vis a vis AI), the labor force continues to grow (in spite of the last parenthetical statement), inflation drops to 2% and stays there, the pace of deglobalization is not disruptive, and bubbles don’t burst. It is technically possible, but we are mindful of the possibility the economy goes the way of the wide road.
