Investing

Do Required Personal Finance Classes Work?

James Bailey1 Comment

41 states now require students to take a course in economics or personal finance in order to graduate high school:

Source: Council for Economic Education

12 states representing 21% of US high schoolers passed mandates for personal finance classes just since 2022. This sounds like a good idea that will enable students to navigate the modern economy. But does it work in practice?

A 2023 working paper “Does State-mandated Financial Education Affect Financial Well-being?” by Jeremy Burke, J. Michael Collins, and Carly Urban argues that it does, at least for men:

We find that the overall effects of high school financial education graduation requirements on subjective financial well-being are positive, between 0.75 and 0.80 points, or roughly 1.5 percent of mean levels. These overall effects are driven almost entirely by males, for whom financial education increases financial well-being by 1.86 points, or 3.8 percent of mean financial well-being.

The paper has nice figures on financial wellbeing beyond the mandate question:

As soon as I heard about the rapid growth in these mandates from Meb Faber and Tim Ranzetta, I knew there was a paper to be written here. I was glad to see at least one has already tackled this, but there are more papers to be written: use post-2018 data to evaluate the new wave of mandates, evaluate the economics mandates in addition to the personal finance ones, and use a more detailed objective measure like the Survey of Consumer Finances.

There’s also more to be done in practice, hiring and training the teachers to offer these new classes:

our estimates are likely attenuated due to poor compliance by schools subject to new financial education curriculum mandates. Urban (2020) finds evidence that less than half of affected schools may have complied. As a result, our estimated overall and differential effects may be less than half the true effects

META Stock Slides as Investors Question Payout for Huge AI Spend

Scott BuchananLeave a comment

How’s this for a “battleground” stock:

Meta stock has dropped about 13% when its latest quarterly earnings were released, then continued to slide until today’s market exuberance over a potential end to the government shutdown. What is the problem?

Meta has invested enormous sums in AI development already, and committed to invest even more in the future. It is currently plowing some 65% (!!) of its cash flow into AI, with no near-term prospects of making big profits there. CEO Mark Zuckerberg has a history of spending big on the Next Big Thing, which eventually fizzles. Meta’s earnings have historically been so high that he can throw away a few billion here and there and nobody cared. But now (up to $800 billion capex spend through 2028) we are talking real money.

Up till now Big Tech has been able to finance their investments entirely out of cash flow, but (like its peers), Meta started issuing debt to pay for some of the AI spend. Leverage is a two-edged sword – – if you can borrow a ton of money (up to $30 billion here) at say 5%, and invest it in something that returns 10%, that is glorious. Rah, capitalism! But if the payout is not there, you are hosed.

Another ugly issue lurking in the shadows is Meta’s dependence on scam ads for some 10% of its ad revenues. Reuters released a horrifying report last week detailing how Meta deliberately slow-walks or ignores legitimate complaints about false advertising and even more nefarious mis-uses of Facebook. Chilling specific anecdotes abound, but they seem to be part of a pattern of Meta choosing to not aggressively curtail known fraud, because doing so would cut into their revenue. They focus their enforcement efforts in regions where their hands are likely to be slapped hardest by regulators, while continuing to let advertisers defraud users wherever they can get away with it:

…Meta has internally acknowledged that regulatory fines for scam ads are certain, and anticipates penalties of up to $1 billion, according to one internal document.

But those fines would be much smaller than Meta’s revenue from scam ads, a separate document from November 2024 states. Every six months, Meta earns $3.5 billion from just the portion of scam ads that “present higher legal risk,” the document says, such as those falsely claiming to represent a consumer brand or public figure or demonstrating other signs of deceit. That figure almost certainly exceeds “the cost of any regulatory settlement involving scam ads.”

Rather than voluntarily agreeing to do more to vet advertisers, the same document states, the company’s leadership decided to act only in response to impending regulatory action.

Thus, the seamy underside of capitalism. And this:

…The company only bans advertisers if its automated systems predict the marketers are at least 95% certain to be committing fraud, the documents show. If the company is less certain – but still believes the advertiser is a likely scammer – Meta charges higher ad rates as a penalty, according to the documents. 

So…if Meta is 94% (but not 95%) sure that an ad is a fraud, they will still let it run, but just charge more for it.  Sweet. Guess that sort of thinking is why Zuck is worth $250 million, and I’m not.

But never fear, Meta’s P/E is the lowest of the Mag 7 group, so maybe it is a buy after all:

Source

As usual, nothing here should be considered advice to buy or sell any security.

Optimal Portfolio Weights

Zachary Bartsch6 Comments

All of us have assets. Together, they experience some average rate of return and the value of our assets changes over time. Maybe you have an idea of what assets you want to hold. But how much of your portfolio should be composed of each? As a matter of finance, we know that not only do the asset returns and volatilities differ, but that diversification can allow us to choose from a menu of risk & reward combinations. This post exemplifies the point.

1) Describe the Assets

I analyze 3 stocks from August 1, 2024 through August 1, 2025: SCHG (Schwab Growth ETF), XLU (Utility ETF), and BRK.B (Berkshire Hathaway). Over this period, each asset has an average return, a variance, and  co-variances of daily returns. The returns can be listed in their own matrix. The covariances are in a matrix with the variances on the diagonal.

The return of the portfolio that is composed of these three stocks is merely the weighted average of the returns. In particular, each return is weighted by the proportion of value that it initially composes in the portfolio. Since daily returns are somewhat correlated, the variance of the daily portfolio returns is not merely equal to the average weighted variances. Stock prices sometimes increase and decrease together, rather than independently.

Since the covariance matrix of returns and the covariance matrix are given, it’s just our job to determine the optimal weights. What does “optimal” mean? This is where financiers fall back onto the language of risk appetite. That’s hard to express in a vacuum. It’s easier, however, if we have a menu of options. Humans are pretty bad at identifying objective details about things. But we are really good at identifying differences between things. So, if we can create a menu of risk-reward combinations, then we’re better able to see how much a bit of reward costs us.

2) Create the Menu

In our simple example of three assets, we have three weights to determine. The weights must sum to one and we’ll limit ourselves to 1% increments. It turns out that this is a finite list. If our portfolio includes 0% SCHG, then the remaining two weights sum to 100%. There are 101 possible pairs that achieve that: (0%, 100%), (1%,99%), (2%,98%), etc. Then, we can increase the weight on SCHG to 1% for which there are 100 possible pairs of the remaining weights: (0%,99%), (1%, 98%), (2%, 97%), etc. We can iterate this process until the SCHG weight reaches 100%. The total number of weight combinations is 5,151. That means that there are 5,151 different possible portfolio returns and variances. The below figure plots each resulting variance-return pair in red.

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Is Tesla Stock Grossly Overpriced?

Scott Buchanan1 Comment

One of the more polarizing topics in investing is the valuation of Tesla stock. Its peers among the Magnificent 7 big tech leaders sport price/earnings ratios mainly in the 30s. Those are high numbers, but growth stocks deserve high P/Es. A way to normalize for expected growth of earnings is to look at the Price/Earnings/Growth (PEG) ratio. This number is usually 1.5-2.0 for a well-regarded company. Anything much over 2 is considered overvalued.

Tesla’s forward P/E of about 270 is nearly ten times higher than peers. Its anticipated growth rate does not seem to justify this astronomical valuation, since its PEG of around 4-10 (depending on assumptions) is way higher than normal. This seems to be a case of the CEO’s personal charisma dazzling shareholders. There is always a new “story” coming out to keep the momentum going.

Tesla’s main actual business is selling cars, electric cars. It has done a pretty good job at this over the past decade, supported by massive government subsidies. With the phasing out of these subsidies by the U.S. and some other governments, and increasing competition from other electric carmakers, it seems unlikely that this business will grow exponentially. Ditto for its smallish ($10 billion revenue) business line of supplying large batteries for electric power storage. But to Tesla fans, that doesn’t really matter. Tesla is valued, not as a car company, but as an AI startup venture. Just over the horizon are driverless robo-taxis (whose full deployment keeps getting pushed back), and humanoid Optimus robots. The total addressable market numbers being bandied about for the robots are in the trillions of dollars.

Source: Wikipedia

From Musk’s latest conference call:

Optimus is Tesla’s bipedal humanoid robot that’s in development but not yet commercially deployed. Musk has previously said the robots will be so sophisticated that they can serve as factory workers or babysitters….“Optimus will be an incredible surgeon,” Musk said on Wednesday. He said that with Optimus and self driving, “you can actually create a world where there is no poverty, where everyone has access to the finest medical care.”

Given the state of Artificial General Intelligence, I remain skeptical that such a robot will be deployed in large numbers within the next five years. It is of course a mind-bending exercise to imagine a world where $50,000 robots could do anything humans can do. Would that be a world where there is “no poverty”, or a world where there is no wealth (apart from the robot owners)? Would there be a populist groundswell to nationalize the robots in order to socialize the android bounty? But I digress.

On the Seeking Alpha website, one can find various bearish articles with the self-explanatory titles of, for instance, Tesla: The Dream Factory On Wall Street, Tesla: Rallying On Robotaxi Hopium, and Tesla: Paying Software Multiples For A Car Business – Strong Sell . There are also bullish pieces, e.g. here,  here, and here.

Musk’s personal interaction with shares has propped up their value. He purchased about $1 billion in TSLA shares in September. This is chicken feed relative to its market cap and his net worth, but it apparently wowed TSLA fans, and popped the share price. What seems even more inexplicable is the favorable response to a proposed $1 trillion (!!) pay package for Elon. For him to be awarded this amount, Tesla under his watch would have to achieve hefty boosts both in physical production and in stock market capitalization. But… said package would be highly dilutive (like 12%) to existing shareholders, so, rationally they should give it thumbs down. However, it seems likely that said shareholders are so convinced of Musk’s value that they will approve this pay package on Nov 6, since he has hinted he might leave if he doesn’t get it.

Such is the Musk mystique that shareholders seem to feel that giving him an even greater stake in Tesla than he already has  will cause hundreds of billions of dollars of earnings appear from thin air. From the chatter I read from Wall Street professionals, they view all this as ridiculous magical thinking, yet they do not dare place bets against the Musk fanbase: the short interest in TSLA stock is only a modest 2.2%. Tesla is grossly overvalued, but it will likely remain that way as long as Elon remains and keeps spinning grand visions of the future.

Looking Ahead: Post-Powell Interest Rates

Zachary BartschLeave a comment

Jerome Powell’s term as Fed Chair ends in late May 2026. President Trump has said that he will nominate a new chair and the US senate will confirm them. It may take multiple nominations, but that’s the process. The new chair doesn’t govern monetary and interest rate policy all by their lonesome, however. They have to get most of the FOMC on board in order to make interest rate decisions. We all know that the president wants lower interest rates and there is uncertainty about the political independence of the next chair. What will actually happen once Jerome is out and his replacement is in?

The treasury markets can give us a hint. The yields on government debt tend to follow the federal funds rate closely (see below). So, we can use some simple logic to forecast the currently expected rates during the new Fed Chair’s first several months.

https://fred.stlouisfed.org/graph/?g=1NwVQ

Here’s the logic. As of October 16, the yield on the 6-month treasury was 3.79% and the yield on the 1-year treasury was 3.54%. If the market expectations are accurate, then holding the 1-year treasury to maturity should yield the same as the 6-month treasury purchased today and then another one purchased six months from now. The below diagram and equation provide the intuition and math.

Since the federal funds rate and US treasury yields closely track one another, we can deduce that the interest rates are expected to fall after 6 months. Specifically, rates will fall by the difference in the 6-month rates, or about 49.9 basis points (0.499%).  This cut is an expected value of course. Given that the cut is between a half and a zero percent, we can back out the market expectation of for a 0.5% vs 0.0% cut where α is the probability of the half-point cut.* Formally:

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Does Trump Weaken the US Dollar?

Zachary Bartsch2 Comments

Talk to some economists and they’ll tell you that exchange rates aren’t economically important. They say that exchange rates between countries are a reflection of supply and demand for one another’s stuff. So, at the macro, it’s a result and not a determinant of transnational economic activity.

For individual firms at the micro level, it’s the opposite. They don’t affect the exchange rate by their lonesome and are instead affected by it. If you have operations in a foreign country, then sudden changes to the exchange rate can cause your costs to be much higher or lower than you had anticipated. The same is true when you sell in a foreign country, but for revenues. This type of risk is called ‘exchange rate risk’ since it’s possible that none of the prices in either country changed and yet your investment returns change merely because of an appreciated currency.

Supply & Demand

Exchange rates are determined by supply and demand for currencies. Demand is driven by what people can do with a currency. If a country’s goods become more attractive, then demand for those goods rise and demand for the currency rises. After all, most retailers and wholesalers in the US require that you pay using US dollars. Importantly,  it’s not just manufacturing goods that drive demand for currency. Demand for services, real estate, and financial assets can also affect the supply and demand for currency. In fact, many foreigners  are specifically interested in stocks, bonds, US treasuries, and other investments. The more attractive all of those things are, the more demand there is for them.

Of course, the market for currency also includes suppliers. Who does that? Answer: Anyone who holds dollars and might buy something. Indeed, all buyers of goods or financial products are suppliers of their medium of exchange. In the US, we pay in dollars. Especially since 1972, suppliers have also included other central banks and governments. They treat the US currency as if it’s a reserve of value, such as gold, that can be depended upon if they need a valuable asset (hence the name, “Federal Reserve”). This is where the term ‘reserve currency’ comes from – not from the dollar-denominated prices of some internationally traded commodities. Though, that’s come to be an adopted meaning.  

Another major supplier of currency is the US central bank. It has the advantage of being able to print US dollars. But it doesn’t have an exchange rate policy. So, it’s not targeting a particular price of the US dollar versus any other currency. The Fed does engage in some international reserve lending, but it’s not for the purpose of supplying currency to foreign exchange markets.  

The US Exchange Rate in 2025

One of the reasons that the US has such popular financial assets is that we have highly developed financial markets and the rule of law. People trust that, regardless of the individual performance of an asset, the rules of the game are mostly known and evenly applied. For example, we have a process to follow when bond issuers default. So, our popularity is not merely because our assets have higher returns. Rather, US investment returns have dependably avoided political risk – relative to other countries anyway.

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Circular AI Deals Reminiscent of Disastrous Dot.Com Vendor Financing of the 1990s

Scott BuchananLeave a comment

Hey look, I just found a way to get infinite free electric power:

This sort of extension-cord-plugged-into-itself meme has shown up recently on the web to characterize a spate of circular financing deals in the AI space, largely involving OpenAI (parent of ChatGPT). Here is a graphic from Bloomberg which summarizes some of these activities:

Nvidia, which makes LOTS of money selling near-monopoly, in-demand GPU chips, has made investing commitments in customers or customers of their customers. Notably, Nvidia will invest up to $100 billion in Open AI, in order to help OpenAI increase their compute power. OpenAI in turn inked a $300 billion deal with Oracle, for building more data centers filled with Nvidia chips.  Such deals will certainly boost the sales of their chips (and make Nvidia even more money), but they also raise a number of concerns.

First, they make it seem like there is more demand for AI than there actually is. Short seller Jim Chanos recently asked, “[Don’t] you think it’s a bit odd that when the narrative is ‘demand for compute is infinite’, the sellers keep subsidizing the buyers?” To some extent, all this churn is just Nvidia recycling its own money, as opposed to new value being created.

Second, analysts point to the destabilizing effect of these sorts of “vendor financing” arrangements. Towards the end of the great dot.com boom in the late 1990’s, hardware vendors like Cisco were making gobs of money selling server capacity to internet service providers (ISPs). In order to help the ISPs build out even faster (and purchase even more Cisco hardware), Cisco loaned money to the ISPs. But when that boom busted, and the huge overbuild in internet capacity became (to everyone’s horror) apparent, the ISPs could not pay back those loans. QQQ lost 70% of its value. Twenty-five years later, Cisco stock price has never recovered its 2000 high.

Beside taking in cash investments, OpenAI is borrowing heavily to buy its compute capacity. Since OpenAI makes no money now (and in fact loses billions a year), and (like other AI ventures) will likely not make any money for several more years, and it is locked in competition with other deep-pocketed AI ventures, there is the possibility that it could pull down the whole house of cards, as happened in 2000.  Bernstein analyst Stacy Rasgon recently wrote, “[OpenAI CEO Sam Altman] has the power to crash the global economy for a decade or take us all to the promised land, and right now we don’t know which is in the cards.”

For the moment, nothing seems set to stop the tidal wave of spending on AI capabilities. Big tech is flush with cash, and is plowing it into data centers and program development. Everyone is starry-eyed with the enormous potential of AI to change, well, EVERYTHING (shades of 1999).

The financial incentives are gigantic. Big tech got big by establishing quasi-monopolies on services that consumers and businesses consider must-haves. (It is the quasi-monopoly aspect that enables the high profit margins).  And it is essential to establish dominance early on. Anyone can develop a word processor or spreadsheet that does what Word or Excel do, or a search engine that does what Google does, but Microsoft and Google got there first, and preferences are sticky. So, the big guys are spending wildly, as they salivate at the prospect of having the One AI to Rule Them All.

Even apart from achieving some new monopoly, the trillions of dollars spent on data center buildout are hoped to pay out one way or the other: “The data-center boom would become the foundation of the next tech cycle, letting Amazon, Microsoft, Google, and others rent out intelligence the way they rent cloud storage now. AI agents and custom models could form the basis of steady, high-margin subscription products.”

However, if in 2-3 years it turns out that actual monetization of AI continues to be elusive, as seems quite possible, there could be a Wile E. Coyote moment in the markets:

Economic Freedom of the World 2025

James Bailey1 Comment

The Fraser Institute released their latest report on the Economic Freedom of the World today, measuring economic policy in all countries as of 2023. They made this excellent Rosling-style graphic that sums up their data along with why it matters:

In short: almost every country with high economic freedom gets rich, and every country that gets rich either has high economic freedom or tons of oil. This rising tide of prosperity lifts all boats:

This greater prosperity that comes with economic freedom goes well beyond “just having more stuff”:

The full report, along with the underlying data going back to 1970, is here. The authors are doing great work and releasing it for free, so no complaints, but two additional things I’d like to see from them are a graphic showing which countries had the biggest changes in economic freedom since last year, and links to the underlying program used to create the above graphs so that readers could hover over each dot to identify the country (I suppose an independent blogger could do the first thing as easily as they could…).

FRDM is an ETF that invests in emerging markets with high economic freedom (I hold some), I imagine they will be rebalancing following the new report.

Leveraged Bullion and Mining Funds to Cash in on the Gold Bonanza

Scott BuchananLeave a comment

Stocks (e.g., S&P 500) are up 12.5 % year to date. That is pretty good for 9.5 months. But gold has been way better, up 40%:

Fans of gold cite various reasons for why its price should and must keep going up (out of control federal debt and associated money-printing, de-dollarization by non-Western nations, buying by central banks, etc.). I have no idea if that is true. But if it is, that raises the question in my mind:  for the limited amount of funds I have to invest in gold, can I get more bang for my investing bucks, assuming gold continues to rise?

It turns out the answer is yes.  A straightforward way is to buy into a fund which is 2X or 3X leveraged to the price of gold. If gold goes up 10%, then such a fund will go up 20% or 30%. Let’s see how two such funds have done this year, UGL (a large 2X gold fund) and a newer, smaller 3X fund, SHNY:

Holy derivatives, Batman, that leverage really works! With GLD (1X gold) up 40%, UGL was up 80% year to date, and 3X SHNY is up 120%. So, your $10,000 would have turned into $24,000. The mighty S&P500 (blue line) looks rather pitiful in comparison.

But wait, there’s more. Let’s consider gold “streamers”, like WPM (Wheaton Precious Metals) or FNV. They give money to mines in return for a share of the production at fixed, discounted prices, so their cash flow soars when gold prices rise. Year to date, FNV is up 73%, while WPM is up 91%.

And then there are the gold miners themselves. They tend to have fairly fixed breakeven costs of production, currently around $1200-1400/oz.  Again, their profit margin rockets upward when gold prices get far above their breakeven:

Source

GDX is a large fund of representative mining stocks. For icing on the cake, there are funds that are 2X (NUGT) or 3X (GDXU) leveraged to the price changes in mining stocks. The final chart here displays their year-to-date performance in all their glory:

The blue S&P 500 line is lost in the noise, and even the orange 40% GLD line is left in the dust. The 1X miner fund was up 108%, the 2X fund NUGT was up 276%, and the 3X GDXU was up 506%. Your $10,000 would have turned into $51,000.

Of course, what goes up fast will also come down fast, since leverage works both ways. For instance, from Oct 21 to Dec 30, 2024, gold was down a mere 4%, but WPM was down 15%, the 1X gold miner GDX was down 20%, and 3X GDXU down an eye-watering 54%. That means that your $10,000 turned into $4,600 in two months. Imagine watching that unfold, and not panic-selling at the bottom. Gold fell by more than half between 2011 and 2015. If it fell by even 20% (i.e., gave up half of this year’s gains), I could see a 3X miner fund losing over 90% of its value (just a guess).

One more twist to mention here is the “stacked” fund GDMN, which uses derivatives to be long 1X gold PLUS 1X gold miners. It is up 151% this year, which is nearly four times as much as gold. This fund seems to have a nice combination of decent leverage with moderate volatility. It has on average kept pace with the 2X miner fund NUGT, with shallower dips. NUGT has surged way ahead in the past two months as miner stock prices have gone nuts, but that is somewhat exceptional.

Disclaimer: As usual, nothing here should be considered advice to buy or sell any security.

Don’t Cut Rates

James Bailey2 Comments

The Federal Reserve will probably cut rates next week:

I can’t advise them on the complex politics of this, but based on the economics I think cutting would be a mistake. I see one good reason they want to cut: hiring is slow and apparently has been for a year. But that could be driven by falling labor supply rather than falling demand, and most other indicators suggest holding rates steady or even raising them.

Most importantly, inflation is currently well above their 2% target, 2.9% over the past year and a higher pace than that in August. Inflation expectations remain somewhat elevated. Real GDP growth was strong in Q2 and looks set to be strong in Q3 too, and NGDP growth is still well above trend.. The Conference Board’s measure of consumer confidence looks bad, but Michigan’s looks fine.

Financial conditions are loose, with stocks at all time highs and credit spreads low. Its only September and we’ve already seen more Initial Public Offerings than in any year since 2021 (when the last big bout of inflation kicked off):

Source: https://stockanalysis.com/ipos/statistics/

Crypto prices are back near all time highs and crypto is becoming more integrated into public stocks through bitcoin treasury companies and IPOs from Gemini and Figure.

The Taylor Rule provides a way of putting all this together into a concrete suggestion for interest rates. Some versions of the rule say rates are about on target, while others including my preferred Bernanke version suggest they should be closer to 6%. To me this is what the debate should be- do we keep rates steady or raise them? I see good arguments each way, but the case for a cut seems very weak.

I look forward to finding out in a year or two whether I or the FOMC is the crazy one here.

* The Usual Disclaimer, hopefully extra obvious in this case: These views are mine and I’m not speaking for any part of the Federal Reserve System.