Come on Silver Lady, take my word
by Doug Brodie
/1. The make-up of investment growth
The Ibbottson study ("Long-Run Stock Returns: Participating in the Real Economy" by Roger G. Ibbotson and Peng Chen Financial Analysts Journal, Volume 59, Issue 1, January/February 2003) decomposed returns from 1926 to 2000, which averaged annually 10.70%, as follows:
Inflation: 3.08%
Real EPS Growth: 1.75%
P/E Ratio Growth: 1.25%
Income Return (Dividends): 4.62%.
You can read the whole paper online if you want, however, it’s very dry, technical and demonstrates the formulae used to evaluate the different elements of return such as:
/2. Gearing investments – not what you expect
This is an outline of the most common geared investment, from etf.com. This is an American issue, you very rarely see this in the UK because it’s an institutional trading technique given the embedded risks – people can and do lose everything with geared investments, and this summary shows precisely why it is a vehicle for trading, not investing.
What Is a Leveraged ETF?
Leveraged ETFs are exchange-traded funds that allow investors to amplify their returns through the use of financial leverage. These funds typically use derivatives, such as options and futures contracts, to achieve a leverage ratio of two or three times the daily performance of a specific index or benchmark.
What Is Leveraged ETF Decay?
It's important to understand what is meant by “decay” in the context of leveraged ETFs. When we say that a leveraged ETF decays, we mean that its returns can diverge significantly from what we might expect based on the performance of the underlying index.
For example, if the underlying index goes up by 1%, we might expect a leveraged ETF that seeks to deliver two times the daily return to go up by 2%. However, due to the effects of decay, the actual return might be less than 2%.
Why Do Leveraged ETFs Decay?
Leveraged ETFs decay due to the compounding effect of daily returns, also known as "volatility drag." This means that the returns of the ETFs may not match the returns of the underlying asset over longer periods.
The reason for this is that the leveraged ETF is designed to provide multiple returns of the underlying asset on a daily basis. The compounding effect of daily returns means that losses in the ETF are magnified over time. If the underlying asset experiences high volatility, the volatility drag will be more significant, resulting in higher losses for the leveraged ETF.
Since leveraged ETFs require added layers of management and specialized trading strategies, investors should also be aware that there are associated costs that can be passed on to investors.
In summary, there are three primary factors that contribute to leveraged ETF decay: compounding, volatility and the cost of leverage.
Compounding
Leveraged ETFs use financial leverage to achieve their desired level of exposure to the underlying index. This means that they borrow money to invest in derivatives that deliver two or three times the daily return of the index. The returns from these investments are then combined with the ETF’s own assets to deliver the leveraged return.
The problem with this approach is that it introduces compounding into the equation. Compounding occurs when the returns from an investment are reinvested, leading to exponential growth over time. In the case of leveraged ETFs, compounding can work against investors when the ETF’s returns are negative. Here’s why...
When the underlying index experiences a loss, the leveraged ETF will also experience a loss. Let’s say, for example, that the index goes down by 10% on day one. If we assume that the leveraged ETF seeks to deliver two times the daily return, we might expect the ETF to go down by 20% on day one. However, because the ETF’s assets have been leveraged, its actual loss might be greater than 20%.
Now, let’s consider what happens on day two. If the index goes up by 10%, we might expect the leveraged ETF to go up by 20%. However, because the ETF’s starting value is now lower than it was on day one, the actual return might be less than 20%. In fact, it might take a return of more than 25% just to get back to the starting value!
This example illustrates the impact of compounding on leveraged ETFs. When returns are negative, the ETF’s losses can be amplified by the leverage, leading to a larger starting value for the next day’s return. This can make it difficult for the ETF to recover even if the index subsequently experiences gains.
Example
To understand how volatility contributes to decay in a leveraged ETF, let's take an example. Suppose an investor invests $100 in a 2x leveraged ETF that tracks the S&P 500 index. On the first day, the S&P 500 index goes up by 1%, and the ETF provides a return of 2%, resulting in a value of $102 for the investment.
On the second day, the S&P 500 index goes down by 2%, and the ETF provides a return of -4%, resulting in a value of $97.92 for the investment. Over two days, the S&P 500 index has gone down by 1%, but the leveraged ETF has lost more than 2% due to the compounding effect of daily returns.
In a volatile market, where the underlying asset experiences large daily swings, the compounding effect of daily returns can cause the leveraged ETF to lose value rapidly. This is because losses are magnified over time, and gains are not enough to offset the losses.
With thanks to our learned chums at etf.com.
/3. Tariffs – what Trump has done to smoothies, mangoes and the Chevy Silverado
Tariffs are being applied by Trump because he dislikes the balance of trade – countries are selling more to America than they are buying from it. Which happens to be true.
The Anderson Economic Group (AEG) found that vehicles like EV crossovers could have price hikes of over $12,000 depending on the vehicle if proposed tariffs of 25% go into effect on Canadian and Mexican imports.
- Yahoo Finance.
Firstly, 20% of US adult consumers are currently paying $1,000+ in monthly car payments (Yahoo). No wonder they elected a person who promised/guaranteed/swore blind that he would cut their costs.
With its 6.2l v8 engine, on average it currently costs c$55,000. The tariffs are estimated to add another $12,000 to that price, being a 22% increase. Float that through to the monthly finance beloved of the US consumer and the monthly car lease rises from $1,000 to $1,200 – that’s a big squeeze.
They are worried in the US – this is the summary from the Detroit Free Press on which car models are going to be hit:
BMW's plant in San Luis Potosi, Mexico, produces the 3 Series, 2 Series Coupe and M2, with nearly all output going to the U.S. and other markets worldwide.
Ford Motor Co. has three plants in Mexico. It exported just under 196,000 cars to North America in the first half of 2024, with 90% going to the U.S., according to Mexico's AMIA.
General Motors imported roughly 750,000 vehicles from Canada or Mexico in 2024 to the U.S., with most made in Mexico, GlobalData says. They include the Chevy Silverado, GMC Sierra full-size pickups, and midsize SUVs. The Mexican plants also build two of its new EVs. GM's three plants in Canada produce electric vans, the Chevrolet Silverado Heavy Duty truck, and the V8 engine and dual-clutch transmission.
Honda Motor sends 80% of its Mexican output to the U.S. market. It warned on Nov. 6 that it would have to consider shifting production if the U.S. imposed permanent tariffs on Mexican imports.
South Korea's Kia Corp. has a factory in Mexico that makes its own vehicles and some Santa Fe SUVs for its affiliate Hyundai Motor for export to the United States.
Mazda exported around 120,000 vehicles from Mexico to the United States in 2023, but said it may reconsider further investments if tariffs are imposed.
Nissan Motor has two plants in Mexico where it makes the Sentra, Versa and Kicks models for the U.S. market. It produced nearly 505,000 vehicles in Mexico in the first nine months of 2024.
Stellantis operates assembly plants in Mexico making Ram pickups and vans, as well as the Jeep Compass midsize SUV. The group owns two assembly plants in Canada, one where it makes Chrysler models and another scheduled to resume output of a new Jeep model this year.
Toyota Motor builds its Tacoma pickup truck at two plants in Mexico, and sold more than 230,000 of them in the U.S. in 2023, or 10% of total sales in that market.
Volkswagen's factory in Puebla, Mexico, made nearly 350,000 cars in 2023, including the Jetta, Tiguan and Taos, all for export to the U.S. In Canada, Volkswagen is building a battery gigafactory in Ontario, with output to begin by 2027. Volkswagen's Audi plant in San Jose Chiapa, Mexico, makes the Q5, employing more than 5,000 people. In the first half of 2024, nearly 40,000 vehicles were exported to the U.S., according to Mexico's AMIA.
I printed this long list to emphasise just how broadly hit the US consumer is going to be – this cannot do anything for US consumer inflation other than raise it.
More, have a look at what it does to the small US businesses that are the backbone of the US economy:
Brothers International Food Holdings, based in Rochester, N.Y., imports mangoes and avocados from Mexico and sells fruit juices, purées and frozen-food concentrates to food and beverage manufacturers. New tariffs are forcing the 95-person company to pass on price increases to its customers or accept lower profit margins.
It’s a very simple business, however it relies on the processing of imported fruit. It provides employment and revenue to the growers and processors in countries from Ecuador to Kenya to Borneo, and provides (much needed) healthy food to the US consumer. Inadvertent collateral damage. It employs 95 people – it’s not a conglomerate, it’s a medium-sized business that is having an XL-sized problem foisted on it.
/4. The difference between Bill Gates and Warren Buffett, in Warren’s words.
Firstly, we often tell clients to delete any pension app from their phone, and that’s to ensure they don’t grow anxious and irritable watching values rise and fall, as they are guaranteed to do. Warren Buffett was asked how often he looks at Berkshire’s share price and what triggers his decision to sell:
When you say you don’t even look at the stock market, how often do you look at the price of shares?
I would say that I probably look at the price of Berkshire once every two weeks. Something like that.
That’s it?
Yeah. It doesn’t make any difference. I haven’t bought or sold a share for forty years. Somebody said, “What’s a good time to sell Berkshire?” and I said, “I don’t know. I’ve never sold any.”
In the interview he explained that he was visiting 48 universities in a year, of which only three were outside the US.
I’m seeing people that kind of remind me of myself when I look out there.
They’ve got lots of energy, they’re smarter than I was, but they’re looking forward to doing the same thing I’ve done. They look at me and they think, “My God, if he can do it, I can do it. It must be easy!” When they look at [Bill] Gates, they don’t think they can do what he did. But when they look at me, they go, “Anybody could do that.”
Bill Gates on Warren:
I couldn’t possibly list all the interests Warren and I share. But one thing we discovered the first time we met is that we both love math and numbers. So in honor of Warren’s birthday, I thought I would share a few numbers related to turning 90—and to our friendship.
30: Number of years Warren has spent sleeping in his lifetime
10,649: Days since we met for the first time, on July 5, 1991
2: Phone numbers I have on speed dial at my office—Melinda’s and Warren’s
Incalculable: The impact Warren has had on the world by committing to give virtually all of his wealth back to society.
/5. When the rich get richer
Money begets money; the chart below shows that the finite number of people who lead the wealth train in the US have acquired an even bigger portion of the country’s wealth over the last 35 years. Back in 1989, the richest pair were Sam Walton of Walmart fame, and John Kluge, a mobile phone and media king.
