Demographics and Destiny

Demographics is destiny, not density. This map shows how many more people live in other countries compared to our own. We can see China and India are the densest and most populated countries.

To understand how this affects the economy, we need to go back to the Keynesian model. It shows Gross Domestic Product (GDP) equals consumption plus investment plus government spending, and exports and imports will have some effect. The two things that matter the most are consumption and investment choices. Everyone is constantly consuming things, but some have different ratios on consumption versus investment.

GDP measurement

GDP = C + I + G + (X – M)

(Consumption and Investment)

Senior Population

If you look at the senior population, frequently industrialized and developed nations have significant savings from the previous production. When we think about them as only consumers, it’s a lowercase c. Why? Because many people call them “annoyingly wise” with their consumption. In other words, they have to be much wiser on how they consume. We would consider this lifestyle bucket to have many savings if it’s an industrialized country, but there are low consumers in the GDP model.

Producer Population

Now, if we look at the producer population, they will be consumers while being significant producers. Goods that are coming into the economy will be produced by the age group of 18-65. Their choices between consuming versus investing will be highly related to how many people are dependent upon them.

Suppose you look back to the senior population, and they don’t have savings to live off of. In that case, they’re going to put a drag on the producer population because their consumption versus investment choices are different. Meaning they may have a parent to be supported. This leads to less money for investment causing GDP to grow more dramatically. Therefore, the lower the senior population dependency on the producer population, the faster the GDP can grow.

Borrowing Population

Then there’s the borrowing population. This population is no longer in childhood, and they are getting educations, starting families, or starting their first job. They are not big producers yet, but they have a lot of demand for borrowing because they’re investing in future production. They have a symbiotic relationship with the senior population because they can loan to this group as they develop their skills.

Child Population

The child population is a significant factor in the producer population regarding consumption. If you don’t have many kids, you tend to have more investment in other things in your life. Therefore, children will be a big part of the producer’s consumption versus investment choices. Just because children are mainly only consumed does not mean that’s a drawback because they’re detrimental to long-term growth. Remember, they’re the future producers as well.

Expanding Population

The population pyramid above is an expanding population often relating to an expanding economy with the age bands on the left. Then, you have it divided by how many people are male or female. For productivity of making more children, the ratio of women is far more critical than the number of men. It’s the norm of the population, when the more women you have, the higher the fertility rate. The ratio of men to women will have different economic impacts, like China has fewer women than men because of their prior one-child policy.

If you look at the pyramid, we can see that the segment comprises mainly young people. The further we go up the less impact that has. This is met with good capital structure and technology and could be a booming economy in the next 20 to 30 years.

Stationary Population

Here is a stationary population. We see the children and the producing population are pretty steady. However, there is a little bit of a decrease here, but you can easily make that up with immigration. We can see that this will be just a stationary economy with no significant liability for demographics in the future.

Population Dividend

Next, we have the population dividend. If you get an example where the fertility rate is low in a country with not many children or elderly for the producer population to support, then the choices on consumption versus investment change. All the excess money is going into the growing the economy faster, which is a massive boon for the economy. The population dividend turns into a population liability.

Population Liability

As individuals retire, there’s a decreasing amount of people that are producing within the economy. If there were plenty of savings that the senior population has to live off during production, then there will be more imports coming in to support them as they decrease spending.

Demographic Comparisons

What are the four countries we have been talking about? The first one expanding is Mexico, with a very young population that is multiplying. The next one, the United States, is right next door to Mexico, where the immigration is coming from the Southern border. The current population dividend is China, and they do not have a lot of savings for their senior and the current producer population. They are becoming wealthier, but not fast. Lastly, we have Japan for population liability. Japan in the eighties-nineties was taking over the world because they were in a population dividend.

Japan and China Comparison

China has a 20-year lag to Japan. Japan was in the expanding phase through the sixties to seventies. Then, they started to move into the producer population. By the eighties to the nineties, they were reaching the population dividend. Then, 2000 happened, and things began to turn, and the economy not growing much since.

Production Function: Growth Rate of GDP Overtime

Y(t)= A(t)K(t)aL(t)1-a

(Current Capital Stock, Technology Development, and Labor Population)

The growth rate of GDP over time has a couple of more factors with a fairly complex equation, but we can keep it simple as:

1. Do you have a current capital structure?

2. Do you have factories and tools that are already there in the economy?

3. Are they good at developing that capital structure further?

These three components are the primary factors on how fast an economy is going to grow over time.

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Keep up to date on Gatewood Wealth Solutions through our daily 3x3s and our weekly market insights on our YouTube, LinkedIn, and Facebook accounts.

Disclosures:

All investing involves risk, including the possible loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

Securities and advisory services are offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC.

Market Bubble?

When we’re thinking about the market, one thing that is on our minds is the market in a bubble? You turn on your TV and, you often get an oversimplified definition: priced earnings P/Es are high, sell your stocks. This is on people’s minds because they see previous valuations in 2000 and 2008. So, it is a fair statement to say valuations are stretched.

Price to Earnings Ratio

The price of the S&P 500 divided by its trailing earnings gives you the price-to-earnings ratio. You can use all sorts of measures for price-earnings, such as trailing or forward. Specifically, we’re using a high standard here.

The graph looks at the last 12 months of earnings and shows how much you pay per dollar of earnings. This is how you can value stock, and you don’t have to worry about inflation. When earnings increase, the value of stocks should, too. Therefore, a relative valutation of price to earnings is a great way to compare stocks prices over time.

What is the Alternative?

The alternative in the year 2000 and 2008 were bonds. If you would have sold in the 2000 timeframe, the ten-year was paying over 5.5%, and inflation was reasonably low, especially during the recession. However, today we don’t have higher yields in the bond market. We’re at 1.74%, and inflation expectations are running at 3.3%. Not only is the interest rate low, but inflation is above what that interest rate is paying.

We wanted to put numbers to the story, so here is a more straightforward way of looking at it.

We are showing 33, as the highest P/E- S&P 500, looking at the past 12 months where we know there were some rough patches. The average for stocks is about 2x higher and 3x higher on the average of bonds. Therefore, bonds could be more overvalued than stocks based on historical standards. The only way to improve the P/E ratio on a bond is to have the price decrease. For stocks, the P/E ratios can improve via a drop in stock price, our fear or by earnings moving up, our hope. Earnings moving up is what we expect for stocks currently.

Earnings Season

As we enter earnings season, the expectations for earnings are high. We’re likely to see “record-breaking” numbers because we’re looking back 12 months ago. There were low to no earnings coming in due to the global pandemic.

Just as we compared bonds to stocks using a P/E multiple, we can easily compare stocks to bonds via a normal valuation for bonds by converting both to a yield. The Fed model above compares the earnings yield of stocks to the earnings yield of a bond. Whenever one is over the other, that’s the undervalued asset class, and you should invest. If we go back to the sixties, you should have been buying stocks, not bonds, based on the earnings yield. Then, to the eighties, we can see both lines matched up together. As interest rates decreased on bonds, stocks looked more attractive and were also bid up at the same rate. We can see the red line (stocks) is over the blue line (bonds) right now. Once again, not just looking at the P/E, but looking at the earnings yield, we can see stocks are more attractive versus bonds looking at the overall investment opportunity set.

Fixed Income Market Dynamics

The interest rate is the downside risk of bonds. At 1.74% on the 10-year, we’re having one of the worst starts over the last 40 years for bonds. Just another 1%, and we would see further decreases of 7-9% in the ten-year treasury. So there’s undoubtedly some downside risk in bonds.

Government spending can cause interest rates to increase because there’s only so much money that can be invested. The way that the U.S. has been offsetting a significant steep increase is by printing money, but that can cause inflation expectations, which can also cause interest rates to move up.

Ultimately, I think the risk for fixed-income is the long-term risk of inflation. Especially at low-interest rates, because if interest rates increase and you see the drop in your treasury, over time, it’s just going to appreciate at the higher interest rate and give you back all the cash you expect.

There’s never going to be any more upside to the bond from when you bought it. So if we had a $1000 bond and it pays us 1% while holding it for 20 years, you will get about $1,200 at the end. $1,200 is more than $1000, but what about that purchasing price in $1,200?

In the cost of basket goods, assume the basket today costs $100. We’re going to inflate it by 2%, 4%, and 6%.

The bond appreciated 20% at a 2% inflation, so the $100 basket of goods cost you $150. Now at 4%, it’s more than double at over $200 in 20 years. It is unusual to see 6% inflation over 20 years, but if you did, it would be over $300. Another way to think about this is to compare the bonds to the cost of goods. In other words, what is the effect of my purchasing power on that basket of goods, assuming that I’ve invested and I’m earning 1% and I’m losing 2%, 4%, or 6%.

In the 2%, you’re losing 1% to inflation each year. At 4%, you’re losing 3%, which has historically been the expected norm for inflation. Then, at 6%, you’re losing over half to inflation each year.

The income that you’re going to get on the bonds will be taxed. Typically you buy bonds where there is some cost or investment management fees. It’s not beyond the realm of possibility to be somewhere between 3-5%, especially since 3% has been the historical norm on the loss of purchasing power. We have a mission to help clients become financially self-reliant, and bonds will not fill that role. Gatewood Wealth Solutions doesn’t see bonds playing a role in preserving purchasing power and wealth at the current low interst rates.

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Keep up to date on Gatewood Wealth Solutions through our daily 3x3s and our weekly market insights on our YouTube, LinkedIn, and Facebook accounts.

Disclosures:

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

All indices are unmanaged and may not be invested directly. The economic forecasts outlined in this material may not develop as predicted, and there can be no guarantee that the strategies promoted will be successful.

All investing involves risk, including the possible loss of principal. No strategy assures success or protects against loss.

Securities and advisory services are offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise, and bonds are subject to availability and change in price.

COVID-19

The global pandemic was a central theme this quarter; going back to the beginning of the year, we can see that there’s been a significant drop in the number of cases, which has helped in the reopening. There’s also the optimism of the COVID vaccine, whether it’s Pfizer, Moderna, or Johnson & Johnson.

As the susceptible population drops, the severity of the outbreaks decline. There is a possible third wave in early Spring, but not as severe as more medical intervention options become available.

Change in Leadership

One theme that also dominated market trends in the first quarter – just as it did in Washington D.C. was a change in leadership leading to government spending and tax changes. President Joe Biden was announced as the 46th President of the United States on January 20, 2021.

President Biden called for returning the top marginal rate to 39.6%, the same rate when President George W. Bush, a Republican, was in office. The 2017 tax cut reduced that rate to 37%. Under Biden’s campaign tax proposal, those annually earning more than $1 million would have to pay higher taxes on capital gains, which typically make up the largest share of income for the wealthy. He would require estates to pay taxes on the unrealized gains on these assets.

As part of his campaign platform, Biden wanted to subject wages of more than $400,000 to Social Security payroll tax, currently capped at $142,800 for 2021. Ultimately he would rewind the estate tax policy to 2009 when the federal exemption was $3.5 million per person, and the rate was 45%. Biden would also reverse part of the 2017 tax cuts to the corporate income tax rate. He would increase it to 28%, up from the current 21%, but not as high as the 35% top rate before the Republican tax breaks.

As tax proposals change, government spending does as well. Biden proposed a $2 trillion bill on infrastructure and jobs. The plan includes everything from road repairs and electric vehicle stations to public school upgrades and training for the clean-energy workforce.

U.S. Deficit Spending is Accelerating the National Debt

Because the infrastructure bill is so high, it will impact the national debt vs. Gross Domestic Product (GDP). All of the Government spendings are starting to show up in statistics and is a concern. The blue line is the national debt. It has continued to increase over the last year. If you look at GDP, the red line, you can see that the debt is outpacing GDP by far. These numbers and the relationship between one another are essential to pay attention to due to inflation.

Inflation Fears

We know the inflation fears exist because people are no longer saying that we won’t have inflation, and we already see the signs of inflation in the graphs below.

The left graph represents the first quarter of 2021 and looks at several U.S. stock market indexes vs. several commodity indexes. Commodities for the quarter have significantly outpaced the stock market indexes. We can also see a similar trend where everything is based on the Dow Jones Industrial Average. The NASDAQ was up more than 9% above the Dow. However, it was nothing compared to the energy index, which was up 20% over the Dow.

Crowding Out Effect

The Government is pulling resources by spending and increasing prices by bidding up, known as Cost Pull. They then decide what investments to make and taxing corporations that reduce their ability to invest in growth (reducing long-term private-sector production). It is not just in the price of things; we see it in the bond market as well.

Inflation Expectations

We see inflation expectations in rising yields between 3-3.2%. Inflation is not something that the government isn’t aware of. It’s something that they are pursuing as a policy, another theme we see in the 1st quarter.

Bond Indexes

For bonds, the first quarter of 2021 was at its worst in over 40 years. The bond sell-off hit treasuries the hardest, followed by safer core and corporate bonds. Only high-yield bonds managed to end the quarter in positive territory.

Equity

Perhaps the most notable change was strength in value stocks, which have been lagging significantly in recent years. Still, the longer-term performance gaps are in favor of growth stock. Long duration is not just a concept in fixed income; it’s a concept in stocks. Stocks that are long duration tend to be growth or technology.

In the Image above we can see the long duration effect on returns. Changes in the discount rate will have a larger impact on Growth than Value and Large cap compared to small cap. There are always other factors to consider, but this showed up for the first quarter. US Large Cap Growth was negative .73%, while Large Value was a strong 10.13%. Small Value was 21.41% while, Small Growth was negative .42%. For the first quarter, the further down market cap and to the value side, the better the performance. This is not the case over the 1 and 3 year time periods. Over the last year, you wanted to be Small with a Growth tilt and over 3 years Large with a Growth tilt. Is this the start of a new rotation away from Growth stocks? This has yet to be determined.

Sector Indexes

The broadening of recovery and rising interest rates boosted cyclical stock sectors during the quarter. Energy stocks gained 31%, and financial services and basic material companies led all other sectors. Defensive sectors suffered, and technology stocks gained the least of any sector for the first time since 2016.

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Keep up to date on Gatewood Wealth Solutions through our daily 3x3s and our weekly market insights on our YouTube, LinkedIn, and Facebook accounts.

Disclosures:

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

All indices are unmanaged and may not be invested directly. The economic forecasts outlined in this material may not develop as predicted, and there can be no guarantee that the strategies promoted will be successful.

All investing involves risk, including the possible loss of principal. No strategy assures success or protects against loss.

Securities and advisory services are offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC.

Air Travel Hitting an All-Time High in the Past Year

The United States has air travel picking back up, hitting the highest level in a year amid eased restrictions. An increase in air travel is very much good news, but it’s going back to that reopening theme and some inflation fears that a lot of people have as we come out of the lockdowns and recession.

Stimulus

For those receiving checks, check your account. If you have not done so already, it should be there. As most of you already know, we had the new stimulus bill (STEMI) passed last week and signed into law by president Biden. However, it has its detractor, and the most vocal regarding the STEMI is Senator Rand Paul. He followed in his father’s footsteps in the Austrian business cycle theory (the philosophy of how economies work). The detractors are about the business cycle caused by monetary policy through central banks. Usually, this does not end well if you continue to grow the economy by just throwing money into the system.

In the quote above, Senator Rand Paul was quoting the non-partisan CBO. He mentions the increase in risk for the financial or fiscal crisis, and in this situation, it could lower confidence in the U.S.’s ability to pay down debt. What he said should cause all the politicians to have some sort of pause.

Diving deeper into that CBO report, they said the reserve status of the U.S. currency is undoubtedly at risk with the amount of spending. By 2050 the amount of revenue that the government is giving, 50% of it needs to go to just pay the interest.

Infrastructure Bill

President Biden is not the first president to say we need to do infrastructure spending. President Trump campaigned on an infrastructure bill. President Obama campaigned on an infrastructure bill. However, we continue not to spend money there. The Government is talking about a $2-4 trillion stimulus bill for infrastructure after the U.S. has already spent $6 trillion in stimulus over the last year.

The administration has also stated that this infrastructure bill should have higher interest rates. So, Treasury Secretary Janet Yellen talks about the need to do this infrastructure and points out the need to fund the higher tax infrastructure bill.

The Biggest Federal Tax Hike Since 1993?

The administration is embarking on what could be the most significant federal tax hike since 1993 to finance an infrastructure plan, Biden’s climate-change initiatives, health care, and economic inequality. Bloomberg has a list of reportedly under consideration proposals, though they all likely won’t make it into the final bill. Notably, the first two bullets would effectively unwind the two most significant Trump tax cuts components.

1. Raising the corporate tax rate to 28% from 21%.

2. Paring back tax preferences for so-called pass-through businesses, such as limited liability companies or partnerships.

3. Raising the income tax rate on individuals earning more than $400,000.

4. Expanding the estate tax’s reach.

5. A higher capital-gains tax rate for individuals earning at least $1 million annually. (Biden on the campaign trail proposed applying income-tax rates, which would be higher).

With all the talk about a federal ‘wealth tax,’ progressives in certain parts of the country are already pushing for state wealth taxes in places like New York – the notion that taxes will move higher under Biden is hardly a surprise.

Just as the Laffer curve results do not square with the image above, why bother with taxes if the infrastructure bill pays for itself? Our view is the monetization of the debt. The political risk of raising taxes will likely keep rates low.

Why bother with taxes at all?

Jeffery Gundlach, an American investor, and businessman states, “80% of the budget is borrowing, so why bother with taxes at all. In other words, he talked about the unlikeliness of taxes increasing substantially.

If you look at what has happened over the last year, 80% of the spending has been met with borrowing or stimulus through the federal reserve. Therefore, our take is that we probably don’t see a massive change in tax policy.

Unknown and Known

The amount of money going into the system is making the deflation argument less impactful. This is something that we know, and there’s plenty of unknowns. We titled this market insights call “Black Swans and Gray Elephants” because there are things that we do know but just not getting a lot of coverage, such as:

• The discussion at the Federal Open Market Committee (FOMC) regarding the supplemental leverage ratio

  • Economists using very obscure language to say very straightforward things

• The measurement of the money supply

  • Change in the measuring of the money supply from weekly to monthly

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Keep up to date on Gatewood Wealth Solutions through our daily 3x3s and our weekly market insights on our YouTube,Facebook, and LinkedIn accounts.

Disclosures:

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

All indices are unmanaged and may not be invested directly. The economic forecasts outlined in this material may not develop as predicted, and there can be no guarantee that the strategies promoted will be successful.

All investing involves risk, including the possible loss of principal. No strategy assures success or protects against loss.

Securities and advisory services are offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC.

$1.9 Trillion Stimulus Bill and $3 Trillion Infrastructure Bill

There has been a lot of noise coming from Washington D.C. regarding the $1.9 trillion stimulus package. It has passed the house and went to the Senate. The Senate then removed the $15 minimum wage due to the parliamentarian rule. Therefore, it is now going back to the house to be approved. Likely by March 12, 2021, President Biden will sign it into law.

The next big package is going to be the infrastructure bill. The current administration anticipates having a proposal out this month; however, it seems that there’s not as much enthusiasm to get another $3 trillion infrastructure spend. However, both Republicans and Democrats are for this bill.

The Recovery and Spending is Putting Upward Pressure on Bonds

The federal government’s amount of money that they are creating and borrowing increases on the curve’s long end. The Feds are still doing their asset purchasing, and there is treasury money sitting there since the previous stimulus bill, but it will eventually be spent down. Therefore, there is a 12% increase in the money supply.

If you subtract the ten-year and the five-year treasuries to get inflation expectations in the medium to long-term, it’s the highest since that number was recorded, about 2005. On a relative basis, we see the expected inflation is higher than it’s been for the last 15 years.

Bond Prices and Interest Rates

If interest rates go up, bond prices go down, and if interest rates go down, bond prices go up. The 7-10 year treasury bonds are down 4.5%, and the S&P 500, at the time of this screenshot, was a positive 4.8- 7%. So, bonds are the way to preserve and remove the downward movement but have not been working so far year to date.

If you’re in an Exchange Traded Fund (ETF) that trades the 20-year maturity, you can see it is down 11.4%.

Inflation Expectations

Two weeks ago, we talked about the market value is and how stocks and bonds are valued the same way they value future cash flows. If the interest rate you’re discounting those future cash flows increases, you’ll see a drop in stock price. However, not all things are equal.

If inflation was more significant, then the risk-free rate increase doesn’t necessarily have a price drop. For example, if you look at future cash flows, on the left, you see a company growing its profit by 5% every year, showing what cash flow would look like. You would discount that by the same factor. Let’s say you were discounting it by 6% on the 10th. It would be 6 to the 10th power (610), and then the 9th would be discounted by 5% to the 9th power (59). So, not all stocks have this same pattern, and very few stocks have that pattern.

The idea is most of the earnings growth in a growth stock is way out in the future. If you’re discounting it and your interest rate changes, you’re going to see a sell-off in those growth stocks more than you would be valued. In simpler terms, the chart on the left shows earnings being paid currently, where the one on the right is the growth stock for you.

Effects on Present Net Value (Stock Price) of Earnings

If you were in long or short duration and interest rates did increase, the net present value of that stock would decline in both scenarios. You’re going to see a significant drop in long-duration stocks, and you’ll see a much smaller change in the short duration. On the other side, if you have falling interest rates, you’re going to see a big jump in growth stocks, and you’re not going to see a big jump in value.

Historically, value has consistently outperformed growth in the long-term, and that has not happened over the last 20 years because we’ve been in a bull market for bonds, meaning that we’ve been in a falling interest rate. Growth stocks dominated performance because of this effect.

How high can interest rates go? The fed has not started to yield curve control (YCC). However, it is likely coming because the U.S. is at $30 trillion in debt, and they cannot afford to pay just the interest with social security and medicare still on their hands. The U.S. has legal obligations that are not discretionary, so at some point, if interest rates get too high and the economy hasn’t grown to a place where tax revenue is high enough to offset it, we are in trouble.

Tech Basket

Tech companies tend to be growth companies that have that long duration that I talked about above. A non-profitable tech company or a company with growth projections in the future and is not profitable now allows us to see and measure their duration. Also, inflation, which is the ability to pass increase costs, needs to have a shorter-term considering the rising rate environment.

Cost-Push — Ability to Pass Increased Costs to Consumers

What is the demand, and what is the structure people will use in their minds whenever they’re budgeting out? If we see inflation, what are the things that are going to continue to be bought?

If commodity prices increase, you will see things being bought that consumers use every day, such as coffee and construction. Technology is one thing that may not be purchased because it has had difficulty pushing off inflation costs due to its deflationary effect. You can see this in the Radio Shack ad that we have mentioned before.

The ad shows a 20-year old $1,600 computer has 20 megabytes. Our phones are 1300 times that, and the drive we use in the office is nine terabytes. The amount of data that we use is all relative. Today’s phones can do everything and more but don’t cost as much as that computer. This is probably the area that we are unlikely to see many inflation costs being pushed out on the consumer.

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If you want to learn more about our firm, we encourage you to visit our newly revamped website with some great information.

Keep up to date on Gatewood Wealth Solutions through our daily 3x3s and our weekly market insights on our YouTube,Facebook, and LinkedIn accounts.

Disclosures:

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

All indices are unmanaged and may not be invested directly. The economic forecasts outlined in this material may not develop as predicted, and there can be no guarantee that the strategies promoted will be successful.

All investing involves risk, including the possible loss of principal. No strategy assures success or protects against loss.

Securities and advisory services are offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC.

You are accustomed to CIO Aaron Tuttle and me speaking on our views of the economy and financial markets every week. However, I had a chance to interview Larry Weiss, a CPA® and a Certified Exit Planning Advisor (CEPA), to discuss how a business owner should consider their exit plan.

Here are his insights on what it means to sell a business, both as the seller and the buyer.

Exit Planning is Critical for Business Owners

One of the more significant parts of exit planning is the life after the plan. Larry takes all of his experience to teach and help privately owned businesses grow, exit, and win. An exit plan asks and answers all the company, personal, financial, legal, and tax questions involved in transitioning a privately owned business.

Baby boomers own the majority of all businesses. Larry says, “a large portion of those owners will eventually transisition in the near future.”

He found that nearly all business owners don’t have a formal plan. Most of the time, they haven’t put together a team to help them with it. From his experience, Larry stated, “nearly all business owners regret selling their business a year later. They don’t regret the price, they regret what happened after the exit, and they just weren’t prepared for it. They went from being the big fish in their pond not even to feel like they had a fishbowl to hang out in.”

Business Owners Fail at Transitioning their Businesses

Often business owners believe they should define a plan right before they are ready to sell; however, the reality of exit planning is that it is more about business strategy. Therefore, your team must know the businesses’ needs and wants long before you think about exiting your business. If they don’t understand those, how will they help create a successful business exit?

Once you can understand the owner’s needs and wants, you will need to know what they want to do in the next chapter. As a business owner, you should know and manage your three gaps to meet your goals.

1. Profit Gap

• The profit you are sacrificing by not operating at a best-in-class level.

2. Value Gap

• The business value you are sacrificing by not operating at a best-in-class level.

3. Wealth Gap

• The additional wealth you need to accumulate to meet your goal

These gaps are crucial to why you want to start the exit planning process early. For example, if you need the business to be worth $10 million, so you can net $7-6 million, you must define a plan to increase your business’s value.

Larry also suggested to grow your clients business to the top line; you should follow the 4 C’s:

1. Human Capital

• Value of talent (your team) that you have in your company

2. Customer Capital

• A measure of the strength of relationships with your clients

3. Social Capital

• How you move information within your company; the culture

4. Structural Captial

• The company’s systems and processes

Types of Exit Plans

Two significant categories exist when talking about an exit plan. You either have internal, or you have external. Internal means it will be intergenerational, such as somebody within the business familiar with it (child, co-worker, partner). However, external is quite varied. It could be a strategic, outside buyer in one company, a few companies in different industries coming together to form a new company, an employee stock option plan, or a financial buyer.

GWS suggests to business owners early enough in the business cycle to set some profits aside to a diversified investment account. The more a business owner has outside the business, the more options they have later.

Business Owner Transactions

The type of transactions that business owners will look to is stock sales vs. asset sales and income transaction vs. capital transaction. Understanding the options and knowing what’s selling the business isn’t as important as what you get from your company. So, part of the process, and one of the reasons you should start early, is to become better informed. Therefore, one of the values of working with an exit planner is they can help educate business owners through all types of issues.

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If you want to learn more about our firm, we encourage you to visit our newly revamped website with valuable information.

Keep up to date on Gatewood Wealth Solutions through our daily 3x3s and our weekly market insights on our YouTube,Facebook, and LinkedIn accounts.

Disclosures:

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

All indices are unmanaged and may not be invested directly. The economic forecasts outlined in this material may not develop as predicted, and there can be no guarantee that the strategies promoted will be successful.

All investing involves risk, including the possible loss of principal. No strategy assures success or protects against loss.

Securities and advisory services are offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC.

Larry Weiss and Weiss Advisors is not affiliated with or endorsed by LPL Financial and Gatewood Wealth Solutions.

Now that the economy is opening up, we are concerned with inflation and lingering high unemployment rates.

Money Supply

If we go back one year, the money supply was at $15.4 trillion, and now it’s at $19.4 trillion. That’s a 25.9% increase. Going back even further, we were at about a 5-6% growth rate each year. Now the growth rate has increased to about 25-26%. That’s a lot of money being produced even as you read this. In fact, money pumping is so prominent today that the Wall Street Journal published an article warning its readers about the amount of money pumping into the system.

Major Spike in Producer Price Index

The Producer Price Index (PPI) jumped significantly last week. PPI measures the average changes in prices received by domestic producers for their output. In other words, if it costs more to make something, you’re probably going to be paying more for it. However, some companies can pass that on, and some cannot. The market started to decline at the same time this spike happened, but I wouldn’t go as far as saying it is the primary source that caused the slowdown in the market appreciation.

Breakeven Inflation Expectations and an 8 Year High

It is not just the PPI causing an effect in our market, but inflation expectations. You can use bond yields over different times with different bonds to estimate the bond market as an inflation premium.

We are at an eight-year high for inflation expectation at 2.2%. Remember, the Fed’s target is 2%, so if you start to look at the bond market, it expects inflation to be at 2.2%. This inflation is essential to pay attention to; we have inflation showing up in the PPI, the money supply is exploding, interest rates are starting to price in inflation expectation, and the inflation hedge commodities are a topic of concern with multiple warning signs.

Broad Basket of Commodities

We can see inflation in commodities when we look past the recent deflationary selloff. The broad commodity index is up only 2-3%, but the inflationary hedges are up tremendously. For example, lumber is up 100%, which we have discussed in previous market insights regarding home builders and citizens moving from urban to suburban areas.

Therefore, as the economy opens up and people start to do things more freely, that will create higher demand and push these prices up. If we focus on the commodity broad basket index, there has been a 50% increase over time. If this trend continues, it will show up with inflation. We had a pullback in the diversified basket of commodity goods of 2-3%, but it will be an issue if this prolonged trend continues.

A New Commodity Supercycle has begun

JP Morgan quant, Marko Kolanovic, and JP Morgan are advocating a supercycle of commodities. The idea is that every 12 years, you shift from a supercycle for commodities to a 12-year cycle where they’re out of favor.

2008 was the end of the last supercycle, also referred to as the rise of China. Since then, no one has wanted to own commodities during the correction. However, we believe a variety of goods will have a special place if inflation shows up going forward.

U.S. Treasuries

Rates, also known as inflation expectations, are moving upward. If you run a trendline in the graph below, you can see people are lending 2.19 for 30 years to the government. You may be thinking, is that extraordinarily high? It is not high at all; however, we can see that interest rates are rising quickly because of inflation expectations increasing.

Higher interest rates should help offset the effects of inflation, but not on the long end of the curve. If the increase in long-dated bonds goes up faster than the short end, then the yield curve will widen. The wider the spread, the easier it is for banks to make money. This incentivizes banks to lend money, expanding the money supply in banks from loans.

For those concerned about market valuations, bonds may not be a great place to go. This was our point last week. The iShares 20+ Year Treasury ETF (TLT) is down nearly 10% year to date. We are only two months in, and this fund is already at a technical correction.

Goldman Sachs Concern in Commodities and the Rising Interest Rate

Goldman Sachs has an ample write-up warning about bonds and an inflationary environment. They look at the classic 60/40 allocation during times when bonds drop in value. During these downward moves, the S&P 500 equities average 4.1%, while the U.S. treasury is down 14.4%.

When we move into an inflationary environment above 3% (with inflation continuing), 60/40 allocations struggle. The 60% equities and 40% bonds are typically considered a balanced portfolio, so you could see less volatility there.

Yellen Defends Biden’s $1.9T Covid-19 Relief Package

What do policymakers say about inflation concerns?

Treasury Secretary Janet Yellen stated, “We think it’s imperative to have a big package that addresses the pain this has caused.” When she was asked whether the surge of federal spending could prompt a sustained rise in the inflation rate, Yellen said it is still a risk. She added that inflation has been very low for many years and that the Federal Reserve has the tools to confront that risk by raising interest rates.

Yellen also mentioned a second economic recovery package that would include spending on longer-term investments, such as infrastructure, renewable energy, education, job training, and research and development. That proposal would also include tax increases on corporations, and wealthy Americans phased in over time, she said.

U.S. Unemployment Rates

In January 2021, the United States unemployment rate has dropped 6.3% as more people continue to find employment. As an additional headwind to unemployment, there could be a $15 minimum wage change. If it passes, we could have higher unemployment. The Congressional Budget Office (CBO) estimates 1.4 million people out of jobs. High unemployment with high inflation is stagflation, a situation in which the inflation rate is high, the economic growth rate slows, and unemployment remains steadily high.

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Keep up to date on Gatewood Wealth Solutions through our daily 3x3s and our weekly market insights on our YouTube, Facebook, and LinkedIn accounts.

Disclosures:

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

All indices are unmanaged and may not be invested directly. The economic forecasts outlined in this material may not develop as predicted, and there can be no guarantee that the strategies promoted will be successful.

All investing involves risk, including the possible loss of principal. No strategy assures success or protects against loss.

Securities and advisory services are offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC.

It is a concern for our clients that the market is potentially overpriced. In this post, we’ll cover this concern conceptually, while also revieweing key formulas and economic concepts. This can be a complex topic, but you are always more than welcome to call the lead advisors on our team at 314.924.5100 to get more clarification.

Market Potentially Overpriced

Looking at earnings ratios, we can see that the P/E rates are well above average. These P/E ratios can undoubtedly be stretched. If we look at this on a historical average, we see the market is overvalued, while interest rates remain low.

Valuing a Perpetuity

A perpetuity is an income payment that will last, in theory, forever. The concept of perpetuity helps us to understand how to discount an income stream permanently.

If you were to look at the formula coupon over the discount factor, it would equal the bond price. In other words, the coupon is the interest rate that is being paid. The discount factor is the interest rate that you’re trying to determine. For example, if you were to have a $1 coupon and a discount factor of five, you would pay $20. However, if the interest rate moves up, bond prices must go down.

Valuing a Stock as a Perpetuity

If you were to look at a preferred stock instead of a bond, preferred stocks would pay dividends. The preferred stock will pay you a certain amount as a dividend, while the valuation of preferred stock would stay the same.

The discount factor is something a bit different when referring to a stock. It’s called the equity risk premium: how much risk you’re taking plus the risk-free rate. Therefore, the equity risk premium is more significant than the corporate bond interest rate. We have consider the equity premium, plus the risk-free rate. The risk-free rate is what you get paid in cash, also known as the inflation rate.

Now, you may realize that dividends are not expected. Some stocks do not have a dividend, but most of the time, when you buy a stock, you expect that stock to grow. You want to increase that dividend that you’re going to expect in the numerator, which would make the stock price go up. However, you want the growth of the stock to happen over a long time. In simpler terms, the stock price is equal to the dividend plus the growth rate over the discount factor minus the company’s growth.

Price to Earnings Ratio

You pay a dividend out of earnings. Your retention rate is subtracted from the earnings, which equals the dividend rate. The payout ratio would be one minus the retention rate. Therefore, you can now justify the price to earnings that’s trading for it.

For example, let’s take the S&P 500 price equation below. We can assume what the ending year earnings are and what they’ll payout as a dividend in the numerator. For the denominator, you should have a good idea of the equity risk premium and the implied rate, because you’re discounting stocks. Also, we know what the risk-free rate is because the Fed is keeping that between 0-25 basis points. Lastly, you should know what the nominal Gross Domestic Product (GDP) would be, meaning that there’s an inflation factor plus the growth of GDP.

These assumptions we make in the equation — which we find using a matrix — matter immensely. The discount factor ranges from 1-10%, and the earnings growth rate ranges from 1-5%. Then, we look at different retention rates or payout ratios to see the current price of the market. What is it telling us, and what would it need to be to justify a price like that?

Again, if you have questions and want to speak to a lead advisor or even those who are not clients of our firm, please learn more about engaging with us by calling 314.924.5100.

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GWS will keep everyone up-to-date on our Daily 3x3s and Weekly Market Insights. Tune in daily at 5 p.m. CT and Wednesdays at 3:30 p.m. CT.

For this week’s full market update, including investment themes updates and risks in 2021, be sure to check out the recording on our YouTube channel.

Disclosures:

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

All indices are unmanaged and may not be invested into directly. The economic forecasts outlined in this material may not develop as predicted, and there can be no guarantee that strategies promoted will be successful.

All investing involves risk, including the possible loss of principal. No strategy assures success or protects against loss.

Securities and advisory services are offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC.

Headlines abounded this week about GameStop, Reddit’s WallStreetBets forum, and retail investors vs. hedge fund managers. It can be enough to make your head spin. Let’s clear things up by digging into five myths surrounding the shorting controversy.

Myth #1: David and Goliath

There is a David-and-Goliath, underdog-type of story going on regarding Game Stop. It is about retail investors using the Robinhood app to coordinate through social media. They’ve just defeated the Goliath, hedge fund Melvin Capital, with the stone of the short squeeze on Game Stop. It’s a fun story, but I would say that this is a myth.

There are many more players behind the scenes in this narrative. It’s not just Robinhood investors. Let’s dive deeper.

Short Selling Stocks

Before we really can understand the story, it’s essential to understand what short selling is. To review: When you buy low and sell high, you can make money in the stock market. You can do the exact opposite where you sell high and buy low, and if they’re the same dollar amounts where you sold and purchased back, you’re going to net the same amount of money.

So, what does it mean when we say somebody shorts a stock? We have somebody that has the stock in their account, somebody that wants to sell it short, and you have the broader market. Here are the five steps:

1. A short seller borrows the stock.

2. The short seller sells the borrowed shares at the current market price.

3. The stock decreased in price as anticipated.

4. The short seller buys back the stock at the lower price and pockets the net difference.

5. The short seller transfers the newly purchased shares back.

However, with GameStop, the steps looked a little bit different.

1. A short seller borrows the stock, GameStop.

2. The stock INCREASED in price going against the short seller.

3. The short seller buys back the stock at a higher price and loses the net difference.

4. The short seller transfers the newly purchased shares back.

Myth #2: Collusion between Hedge Funds and Robinhood

Another myth is that Robinhood and hedge fund Melvin Capital are conspiring behind the scenes.

The understanding is that it’s the broker who sells the stock, and the collateral companies are having to post. With Robinhood, it could be increasing, and it’s not that Melvin Capital made some calls to get this churn through. There is a company out there called DTCC, which is also NSCC. They’re the clearing houses of clearinghouses.

They’re the ones that are transferring the title ownership of a stock and making sure collateral is put up, and money is there. Everything that they do is to ensure an orderly market. The stocks you buy or sell will be transferred to the right owners, and the cash you gave up came into your account.

Myth #3: WallStreetBets Rube, Retail Investors

There’s a myth that WallStreetBets is just a bunch of rube, retail investors.

However, if you were to Google Keith Gill and WallStreetBets, you would see an individual who’s a CFA with a lot of experience running money for massive institutions. He works out of Massachusetts, and he’s a significant influencer on his Reddit forum — that’s right, WallStreetBets.

Influencers like Keith Gill, portfolio managers for a hedge fund, have a lot of market experience. They’re going to go out and build their research to crowdsource using everyone’s information through these Reddit channels, bringing together a good thesis. You have people following this and building their portfolio relative to these influencers’ portfolios. Those are the early investors. Also, there are 2 million to 7 million people following that subreddit.

Myth #4: Wall Street as a Monolith

Another myth is that Wall Street is this giant monolith that is continually changing the game’s rules.

The idea that Wall Street is one big block of people is not accurate. You have the IPO market where banks are going out to help companies get into the secondary market. They are a private company not trading on the exchange. They will also take it and go public, which is a vital part of the market process.

Then you have the investment bankers, people just getting market exposure, wealth management for the retail investor, real estate, etc. All of these players may be one person who’s short and another person that’s long, and they certainly will try to squeeze the other person. You may say this is just a game with no purpose; however, it does serve a purpose. Wall Street is vast, and there are many players with many different angles.

GameStop

GameStop was just selling off, but we knew that this eventually would happen. If the only people buying the stock to push it up are the same people who will need to sell out of stock. If no one else wants to buy at these prices, the value will drop as there is no one to sell the stock at the current price.

On Feb. 2, 2021, it was down 60%, therefore trading below $100 for the day. We’ve probably seen the end of a high in GameStop, but that doesn’t mean that it can’t start all over again.

Passive Investing

Let’s say you were an investor in XRT, which is the CRT SPDR S&P Retail ETF. These are brick and mortar retail spaces. Through the secular trend going towards Amazon, COVID-19, the pandemic, and the lockdowns, it has been a beaten-down ATF.

As of December 2020, when the ETF had closed out, GameStop made up 1.58% of the position. With the run-up, you saw substantial gains in that index, but it was all GameStop.

As of Jan. 29, 2021, GameStop made up almost 20% of the underlying holdings. Therefore, if you were buying XRT, 20% of your proceeds were going into GameStop. This shows that you need to know what you own, which means you’re becoming an active investor if you have to get under the hood frequently. This is part of the risk of that passive investing and how the passive investor could be participating in something that they don’t intend to be.

Silver

The Reddit threads are now moving onto silver, and they’re going to try to do another short squeeze.

It’s far more difficult to corner the market. Some people can bring in silver, whether it’s recycling, mining companies, or silver that you have at your home. There are many ways that silver can come into the market that just were not there for GameStop.

Myth #5: Everything is the Fault of Evil Speculation, which Serves no Purpose

If you want to find who’s to blame for this, my guess is that it is the Federal Reserve with the amount of money they have created. We have $4 trillion of additional funds out there, which is causing extra money to slosh around to the point that if you go into those Reddit chains, you see they call them STEMI checks. My guess is that they took the money they received from the government and put it in the Robinhood account, and that’s the money that helped them speculate.

Also, the Fed has stepped in time and time again. To help keep stock prices higher, they’ve talked about their money bazooka. There’s a false sense of security that these prices will only continue to go up. The Fed’s blame is because they continue to tilt “the field” in favor of higher equity prices. It is also pumping in a lot of additional money into the economy which,h may increase speculation in the market.

That’s all on GameStop and WallStreetBets for now — but we’ll keep you up-to-date on our Daily 3x3s and Wednesday Weekly Market Insights. Tune in daily at 5 p.m. CT and Wednesdays at 3 p.m. CT.

For this week’s full market update, including news on President Biden’s stimulus bill proposal, market movement, and interest rates, be sure to check out the recording on our YouTube channel.

Disclosures:

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

All indices are unmanaged and may not be invested into directly. The economic forecasts outlined in this material may not develop as predicted, and there can be no guarantee that strategies promoted will be successful.

All investing involves risk, including the possible loss of principal. No strategy assures success or protects against loss.

Securities and advisory services offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC.

The fast price swings in commodities will result in significant volatility in an investor’s holdings. Commodities include increased risks, such as political, economic, and currency instability, and may not be suitable for all investors.

Let’s start this week’s update with some significantly good news regarding COVID-19. Cases are declining, likely due to a change in the World Health Organization’s PCR testing on January 13th. The slope is a very noticeable change.

The cycle threshold was set very high, and it was more sensitive to testing for viruses. Therefore, there were a lot more false positives. However, some people believe this was politically motivated, and the data is no longer in a statistical language known as the covariance stationary. Ultimately, how do we know what the impact is?

We hope to see a drop in the death rate; however, I believe there will be a more natural decline. The lower rates are alreay already to lighten lockdown measures. California, New York, Illinois, Michigan, and Massachusetts are easing coronavirus restrictions . There are accusations that the timing of lockdowns are based on politics; however, they are not as straightforward as people make them.

Tax Season is Here

Tax season has arrived! LPL has already started issuing 1099 for accounts that have simple securities. If you have more complex securities that delay their filing, many areas can delay this process. If you don’t have your paperwork yet, starting in February, there will be a batch that gets each week to GWS clients each Friday until February 19th.

Remember, these dates are regulations, not set by LPL or the mutual fund companies.

President Biden’s Proposal

We think that the stimulus bill will be lower than the $1.9 trillion price tag initially put out there. What are the potential holdups with this?

The Biden administration knows they will have to negotiate, so they started at a higher amount; therefore, they can negotiate down to the amount they want to get for stimulus. The big holdup is the $15 minimum wage the Republicans and many Democrats do not want to implement nationally. Many small businesses, which are already facing headwinds, would not be able to absorb that cost.

Janet Yellen Elected as Treasury Secretary

Janet Yellen, the former Chair of the Federal Reserve, is now the Treasury Secretary. Yellen is competent and qualified to do the job that she’s going to do. She strongly believes the stimulus bill needs to be big, and she’s not so much worried about the current debt burden.

This is a problem for a few reasons. Yellen doesn’t think that corporate taxes and tax changes need to happen at the moment. Instead, she maintains we need to have big spending. We will likely see a smaller stimulus bill, but remember, a $3 trillion infrastructure bill is in the works as well. And that will have a lot of bipartisan support, as well.

Our viewers had some commentary regarding cryptocurrency as well as Janet Yellen. She wants to “look closely to encourage their (crypto-currency) use for legitimate activities while curtailing their use for malign and illegal activities.” You could say the same thing about cash. You want to curtail illegal activity because a lot of notorious stuff can be done with the money. You can’t just say that the money is terrible.

Three Main Tenets of the Modern Monetary Theory (MMT)

Let’s go back to basics and look at three key concepts of MMT as they apply to current economic happenings.

1. Treat the Treasury and the Fed as a single entity with a single balance sheet for spending, borrowing, and printing money.

The modern monetary theory is the merging of the treasury. Yellen can print money up while the federal government will no longer go through the treasury but instead can go out to the market and borrow money from savers to fund the Government.

2. Citizens must accept dollars whether they like it or not.

The second idea goes back to that cryptocurrency. The way this works is everyone has to use a type of currency as a medium of exchange. There’s no alternative; however, I think cryptocurrency is acting as an alternative currency right now. Many people are going to that with the dollar’s fear and money created in the system.

3. There is no practical limit to how much debt the United States can issue.

The last idea is the statement that there’s no practical limit to the amount of debt that can be issued. It’s not to say that you would not need to pull back or slow down if there’s inflation, but you can print as much money over the long-term. Ultimately it doesn’t matter because you can always pay your debt back.

Debt

According to the graphic below, we were at $27.8 trillion in federal debt earlier this week. We will be over $30 trillion by the end of the year. If those two stimulus bills pass, looking at the end of President Biden’s current term, the debt could be at $49.4 trillion.

What’s causing the acceleration of the debt over the next four years? There will likely be an additional stimulus and unfunded liabilities on the social security payroll in the next four years. The Government is continuing to spend money because interest rates are low.

Typically, once the Government spends a certain amount of money, they tend not to go back. They always spend for the same projection on the debt clock. We can also ask what a global debt is?

Here in our country, we were at $277 trillion of debt at the end of last year, globally. So let’s put this into simpler terms. The net worth of Jeff Bezos, the president of Amazon, increases by $321 million a day. At that rate, it would take 863,000 days or 2,634 years to pay off the $277 trillion. That’s a lot of debt.

Now, how do all the countries compare in terms of their total debt? The U.S. is about 130% of the Federal debt vs. GDP. If you add in all the other assets, they were undoubtedly very high relative to RJ; for example, China has about 53% of the debt ratio. But that isn’t true because of the way China keeps things off its balance sheet. They’re somewhere around 335%. So debt is across the globe.

Target Inflation Rate

You can see that the red line is the 2% target inflation rate on the chart below. There are many other items that you can buy above the line, such as food, housing, alcohol, etc., and below that is gasoline, airline fares, etc. As states start to reopen from lockdown, the items under the red line will begin to get more attention.

Returns in Different Inflation Environments

In an area where we have high and rising inflation, what are some of the spots that do well? We can see equities do well, but you don’t want to be in bonds or cash if we’re in a high and rising inflation environment.

What about a low inflation environment with rising inflation? Commodities and gold are vital assets to be in, which is the green bars. Once again, equities are doing well, commodities are struggling, and gold is flattering. But you’d rather be in bonds than gold in that environment.

We know we’re not in high inflation at the moment. If we’re in a low inflation environment where they’re falling or rising, the small-cap does well, growth does well, and emerging markets do well in the rising inflation and commodities and gold. However, falling inflation does not.

If we were to look at real estate in an inflationary environment, they do well at 9%, but we think there are fundamental headwinds. With real estate, work from anywhere, and policies to move away from urban to rural, we would not be surprised based on the current trajectory if Miami becomes the financial capital of the U.S. Also, there’s a fundamental reason why small-cap does well. Small-cap companies tend to have the ability to continue to grow market share if they have a new product that’s sought out after.

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For real-time updates, be sure to tune in on Tuesday – Thursday on YouTube LIVE for our “Daily 3×3” live streams and Wednesday for “Market Insights.” Follow us on our Facebook, LinkedIn, and YouTube, so you never miss updates!

Disclosures:

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

All indices are unmanaged and may not be invested into directly. The economic forecasts outlined in this material may not develop as predicted, and there can be no guarantee that strategies promoted will be successful.

All investing involves risk, including the possible loss of principal. No strategy assures success or protects against loss.

We were happy to see a peaceful transition of power at the Presidential Inauguration today and look forward to unifying our country. In today’s update, I’ll cover the proposed stimulus bill and possible tax and infrastructure policies coming out of the new administration.

Biden Unveils $1.9 Trillion COVID Stimulus Plan

President Biden’s proposed stimulus plan includes a central promise for most Americans to receive direct payments of $2,000. However, it has been reduced by $600 from approval by the Congress and President Biden in December. President Biden is pushing for $350 billion in funding assistance for state and local governments plus $20 billion for public transit systems.

President Biden would also like to extend the unemployment benefits until mid-March. What was new with this proposal was that President Biden called for doubling of the minimum wage, from $7.25 to $15 per hour. The wage increase will seek to end the compensation structure for those in the service sector, who are largely compensated through tips and have a minimum wage of $2.13 per hour.

This $1.9 trillion economic package is largely in line with what was previewed by the press. But if you looked at the banks, they were expecting $750 billion to a trillion dollar range. We think a lot of that has to do with President Biden taking a moon shot for negotiation reasons. Not only will the Republicans balk at those numbers, it is probably even overly aggressive for centrist Democrats.

Centrist Policy Views

We have been using a lot of Goldman Sachs analyses, because we believe they have credible information and great visual representation. The graph below shows us the political spectrum that many people in the Senate are falling on.

In the center, we can see that there are more centrist Republicans than extreme Republicans. On the flip side, there are more extreme Democrats than centrist Democrats. Therefore, the Senate has more in common with that centrist Republicans than they do the extreme Democrats.

President Biden has said that he does not want to use the reconciliation process — which requires 60 votes — to pass this bill. Even if the bill were to use reconciliation with a 50-50 split in the Senate and very narrow margins of the house, it would require basically every Democrat to vote unanimously. That’s a pretty tall order, based on the chart above. Therefore, this is likely to constrain what Democrats might accomplish even via that reconciliation.

Second, the reconciliation process has never been used to pass discretionary spending. It appears that half of this proposal (including state and fiscal aid, education grants, and public health spending) will fall in this category where the centrist Democrats probably are going to push back and not pass the bill in its entirety.

Coronavirus Relief and Fiscal Stimulus Proposals

President Biden has released the details of his COVID-relief plan, which the transition team estimates to cost $1.9 trillion (8.6% of GDP). We do not expect all of the elements of the proposal to pass, with revisions in areas that have been contested for some time. Near-term fiscal measures from $750 billion (3.4% of GDP) to $1.1 trillion (5% of GDP). This is likely to be the first of two major proposals with a second proposal dealing with taxes, infrastructure, and benefit programs to pass around mid-year. Again, this is likely why President Biden is putting out such big numbers early on — so he can has negotiating power for a package closer to $1 trillion later in the year.

Will Personal Taxes Rise?

We’ve been getting a lot of questions from clients along the lines of, “With both the House and Senate now controlled by Democrats as well as President Biden, what will it look like under Democratic rule?” We don’t subscribe to dire straights people have put out there that things will be fundamentally different.

Upper-income tax rates will most likely increase to finance other personal tax reductions. But if you look at the graph below, you may be asking yourself who is going to bear the brunt of that at 0.1% or the top 1%? Well, 95-99% percentile and income is going to see a marginal increase in their taxes.

Congress will likely reverse some of the individual income tax changes that Congress passed in 2017, but a net increase in personal taxes is not expected. Specifically, Goldman Sachs believes the top marginal rate to go back to 39.6% from 37% and limitations on itemized deductions to return. However, since the changes the 2017 tax law made in both of those areas expire after 2025, this would only raise around $160 billion over ten years, according to estimates from the Tax Policy Center.

For more context, many of these 2017 tax laws were passed via the reconciliation process at the time. They were only able to pass with a number of timetables and sun setting clauses for when they expire. So, Democrats don’t even necessarily have to increase taxes at this point — they can just let the 2017 tax laws expire, and many of the changes would go away.

We do not think we need to have increases in taxes, but what we do think is more deductions for state and local income and property taxes. A higher income tax and other taxes were benefiting from the deductions. Having some type of slight increase in the taxes with a reduction in or bringing back those itemized deductions in some manner will probably be some type of tax increase.

There have also been questions regarding Social Security taxes. Biden’s proposal is to apply 12.4% of Social Security payroll tax on incomes over $400,000, which would probably be the biggest tax increase seen in his policy. That’s unlikely to go through, because it cannot be done via reconciliation and would need those 60 votes. Therefore, the item that is probably the largest tax increase is arguably the most unlikely to get pushed through.

Will Capital Gains Taxes Increase?

What about capital gains taxes? Capital gains taxes are unlikely to rise as much as President Biden has proposed. During the presidential election campaign, President BIden proposed that long-term capital gains and dividends should be taxed at the rate of ordinary income tax – 39.6% for any individual whose income was over $400,000. It’s harder to roll out any tax increase on capital gains and dividends. However, if the Congress does re-raise the rates on capital gains and dividends, it is a good thing to point to.

Will Corporate Taxes Rise?

Continuing with Goldman’s analysis, they expect that corporate tax increase to be no more than 25%. This is in line with the corporate tax rate that President Biden campaigned on. There is not going to be sufficient support for congressional Democrats to implement these proposals, but there will be enough support amongst centrist Democrats to raise the corporate tax rate, probably around that 25%.

One thing to note is that each percentage point increase will generate a $100 billion in additional revenue, according to models (we all know an increase in taxes would also change behavior). This would increase about $400 billion over the next 10 years. This shows you how much more spending is happening vs. additional revenue.

Infrastructure Plan

The infrastructure plan is likely going to focus on taxes, infrastructure, and renewable energy. The believed price tag is at $3 trillion. We won’t get deep into this yet, since we haven’t even seen a proposal (which will likely come at the end of summer). For the infrastructure build to be proposed, there has to be some type of consensus to the moderate Democrats with some of the Republicans.

Money Supply

The money supply is the green line. We can see that it is above the money supply growth all the way back to 2012. A lot of it is the $600 stimulus checks that are starting to hit people’s banks account and we still have the $1-2 trillion package that is being presented for the next stimulus package.

Fed leadership has been pushing back against premature tapering, which could constrain the money supply growth. They want to see a 2% inflation for a year before raising rates. Why is that important? Usually once it hits an annualized 2%, the central bank would begin to slow the money supply growth because you do need to get ahead of inflation. If you let it continue on for a full year you risk runaway inflation. Fed Chair Powell said the economy is far from the Fed’s employment and inflation goals. Therefore, it is not the time to be talking about exiting the market with a aggressive monetary policy.

Q4 Earnings Begin in Earnest

Earning season is wrapping up this week, even though it is a short week. We are going to see 43 companies in the S&P 500 to report.

The consensus expects the S&P 500 to report the fourth quarter year over year earnings percentage growth of -11% as virus restrictions still are tampering the growth of cyclical sectors.

U.S. Consumer Prices Rise for 7th Straight Month

Now we’re back to our inflation theme. We’ve seen prices rise for seven straight months, a rate we haven’t seem for some time. Consumer price has all items in that basket. There’s still a drag on services, because restaurants and service companies are not moving up. However, we are beginning to see that roll off as well. Commodities are leading the charge (think food bills — we’ve all seen that), but gasoline is beginning to move up as well. A lot of the things that have been holding the Consumer Price Index back, but now have a stabilized based and are beginning to move up.

Price Points for Dollar Cost Averaging

Let’s look at price points. The market continues to trend up. We can see that long-term trend — a slope of about 10% annualized. We expect to see long-term rates around 6% for equity returns after adjusting for inflation. With 10% you’re going to have pullback to dampen that slope as well as inflation pulling some of that off. We are certainly in line with how the market continues to react.

A lot of people are worried about market valuations with the amount of stimulus that is being produced, both fiscal and monetary that the market is acting in a rational way, and it is not significantly overvalued. Everything is certainly priced to rich premiums. However, when you consider other options, we think equity markets are attractive, and that is why they continue to move up.

U.S. Dollar Index

If we look at the dollar index the last couple of weeks, we have seen a stabilized price and the dollar, though we are near lows. We ultimately expect the dollar to push further below and we will move into a cycle where the dollar has been declining relative to other currencies, after it has been strong for so long.

Near Term Relative Strength

Despite severe headwinds for small companies, large businesses increase taxes with a possible increase of the minimum wage, which would certainly hurt the smaller companies. They have a lot of bumps in the road, but nonetheless these companies are outperforming the other sectors. This has been an area that continues to outpace. Just during this time frame, the S&P 500 is the leading index up 6.33% for the year, but obviously things will continue to change.

We expect to see a number of changes over the next 100 days of the Biden administration. We don’t see anything extraordinary that will impact the market negatively, but we are always ready to address black swans.

What’s more important than unknown risk are the unknowable. For now, we believe the market and economy will move forward throughout 2021.

For real-time updates, be sure to tune in on Tuesday – Thursday on YouTube LIVE for our “Daily 3×3” livestreams and Wednesday for “Market Insights.” Follow us on our Facebook, LinkedIn and YouTube so you never miss updates!

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Disclosures:

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful. All investing involves risk including the possible loss of principal. No strategy assures success or protects against loss. Dollar cost averaging involves continuous investment in securities regardless of fluctuation in price levels of such securities. An investor should consider their ability to continue purchasing through fluctuating price levels. Such a plan does not assure a profit and does not protect against loss in declining markets.

The Week of Chaos

I hoped things might settle down between the Senate race and today’s market broadcast (and time of this writing). Instead, the opposite happened.

We saw protesters storming into the Capitol, Twitter canceling and banning President Trump’s account for life, and Congress trying to get Vice President Pence to invoke the 25th amendment, which he did not do. And now they’re looking at the impeachment proceedings once again. Who would have thought all this would happen in one week? Now it is just two weeks until the inauguration of our new president.

It is very interesting that there was an emotional reaction among our society, yet the market has hardly even made a whisper. Usually you would assume that there is a correlation with the market and the media. It just goes to show that the market will ultimately do what the market wants to do.

COVID-19

We continue to see COVID-19 cases reported at an elevated level. But if we were to look at an exponential factor, the curve is that of a quarter of a circle. We can see that the ramp up was an exponential growth line.

At some point the statistics will start to turn over. We hope to pass this over the next couple of weeks to start seeing that average number decline on either a 7 or 14-day average.

Mandates and lockdowns continue to be enforced. California is a current hotspot and is implementing travel restrictions.

Political Environment

President Trump stated that the community should march down Pennsylvania Avenue over a week ago. Nonetheless, there was an altercation with people that were not lawful. It certainly had an impact on people’s feelings about President Trump.

The violence that happened last summer is interesting to compare to the recent violence. Civil disobedience is something that we historically have honored. For example, most Americans actually think the Boston Tea Party was great. It’s part of our history, and we honor it because of how tyrannical the government was. I think that government was a light hand compared to any government that we have now.

Political Party Risks

It’s just a matter of time before the Democrats are looked on as failing. Things are fundamentally changing inside the country that the politics haven’t aligned to yet. So what is the chart below telling you?

In 2008 there was a center, a party within Italy that had gained power. The red is the Democratic party, very similar to the Democratic party in America. They had gained power in 2008 and 2009, then lost it in 2013 to 2014. This ultimately led to the Democratic Party taking power.

This is what happens whenever you lose politics in this environment, where things continue to deteriorate. Then, the five-star movement happened in Italy. So instead of it being a center/right country it moved to a further right political party, and in a sense regained power.

Centralized to Decentralized –> Tech World

The world is changing, and we’re moving from a centralized system that is high, strong, and central to a painfully decentralized system.

This is globalism, where everything is one big market to populism. The populism movement is growing — and it’s not just a United States phenomenon. We also see it in the Eastern European countries.

It’s not surprising to see the world start to mimic the way that the system is organized. Just like there’s been a centralization of authority into the federal system, you also see the same type of concentration of power and centralization into tech companies.

As a result, we have now the opposite movement happening. With the idea of the tech companies, we don’t really own our information. Once we put stuff out there on the internet electronically, that information is grabbed by all these large players through big data systems. They manipulate that data for advertising. The movement now is, “How do I get my information back so that I control it?” That’s decentralization.

China Centralized?

What is the talk about China’s new effort? They’re having this electronic Bitcoin system where everything is done through your phone — again, back to decentralization. I am not the only one to think China is on the rise and that they’re going to beat the United States.

That said, I think they have more problems and are centralizing the pain more than we’re going through right now. I predict America will ultimately come out and be stronger than before. The United States will probably be more decentralized, and China will have more local control. Therefore, I think we’ll end up with a more federal system than what we have right now.

Money Supply

The money supply is growing. We have had two very large stimulus packages this past year and there seems to be another one on the horizon next week. This is what’s driving the market, and it’s very high. We can see just the change in billions of dollars to the money supply added, while seeing 2020 was just very high in the amount of money. Speaking about the government stimulus, it seems as though companies that benefited the most were actually the large companies (even though it was really meant for the small companies).

Investment Themes

Where do we see our focus so far for this year? We continue to see inflation risk as being very high. We’re starting to see that for the past 10 months, oil prices have been high. There’s been a lot of borrowing, especially at the municipal level, since 2013. Therefore, there are indications or anecdotal evidence that we are starting to see that inflation theme begin to pop up food prices. Any additional stimulus is likely to continue to add to this risk of inflation.

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For real-time updates, be sure to tune in on Tuesday – Thursday on our social media for our “Daily 3×3” livestreams and Wednesday for “Market Insights.” Follow us on social media so you never miss a broadcast!

Disclosures:

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful. All investing involves risk including the possible loss of principal. No strategy assures success or protects against loss. Dollar cost averaging involves continuous investment in securities regardless of fluctuation in price levels of such securities. An investor should consider their ability to continue purchasing through fluctuating price levels. Such a plan does not assure a profit and does not protect against loss in declining markets.