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Stimulus

Higher Inflation is Here

By | 2021, Money Moxie, Newsletter | No Comments

In 1979, global oil production dropped roughly 4%, primarily due to the revolution in Iran. This triggered panic among Americans who still remembered the shortages of 1973. The price of oil doubled in 12 months as lines started to build at gas stations, sending prices for all kinds of goods through the roof.

Since World War II ended, U.S. inflation has averaged 3.9%. In the decade prior to 1979, prices averaged a 6.6% increase per year. America had not seen back-to-back double-digit inflation since 1920, but in 1980, prices rose another 13.5%, then 10.3% in 1981. We have not seen anything like this since.

Inflation has been incredibly low over the last 40 years, thanks to technology, globalization, demographics, and the Federal Reserve. During this time, inflation has averaged just 2.7%.

Demand and supply of goods are the basics of economic pricing. If either one rises or falls without the other, prices move. When panic demand for supplies hit in the spring of 2020, we did not see huge changes.

We did see a lot of changes in other areas. Oil demand fell around 10%, and the price of oil at one point went negative. On April 20, 2020, the prices of West Texas Intermediate oil fell to -$40 per barrel. Unbelievable! Companies could not give it away. Gas prices stayed positive (around $1.50 per gallon in Utah).

The U.S. government slammed on the economic brakes and then created around $12 trillion to keep things going. That is in an economy that produces less than $22 trillion in a year. It was massive, and it appears to have worked. Now, the government seems to have the economic tiger by the tail. It is hard to say what will happen if it lets go.

As stimulus efforts continue, prices will probably continue to rise. Official inflation came out on May 13, 2021, at 4.2%. That is a long way from 1979 levels, but it is the biggest number in decades. Many of these numbers are being compared to unusually low prices from a year ago. The Fed refers to this as a base effect.

Fed Chair Jerome Powell insists that these significant increases are temporary. If Powell is correct, then I expect we will begin to see price changes calm down by the end of summer. That does not mean prices will fall; it means they should stop rising so quickly. There is also a reasonable chance the Fed is wrong, so I will be keeping an eye on inflation.

*Research by SFS. Data from the Federal Reserve Bank of Minneapolis and the U.S. Bureau of Labor Statistics. Investing involves risk, including the potential loss of principal. The S&P 500 index is widely considered to represent the overall U.S. stock market. One cannot invest directly in an index. Diversification does not guarantee positive results. Past performance does not guarantee future results. The opinions and forecasts expressed are those of the author and may not actually come to pass. This information is subject to change at any time, based upon changing conditions. This is not a recommendation to purchase any type of investment.

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From Tech-Loving Lockdown to a Stimulus-Charged Reopening?

By | 2021, Money Moxie, Newsletter | No Comments

The stock market does a good job discovering prices, but it gets carried away to extremes by narratives that capture everyone’s attention. When these stories change, the market changes.

In the early days of computing, memory was expensive, and programming in binary code was tedious. To save both money and time, programmers abbreviated years to two digits. For example, the year “1999” would have been recorded as just “99.”

This limitation was widely known going back at least to 1985, but by 1997, it was crunch time. Without a fix, there may or may not have been a valid date in computers for the first day of January 2000. And who would want to be in an elevator or flying in a plane when the clock struck midnight?

This “Year 2000 Problem” became known as Y2K. Companies all over the world were upgrading computer hardware and software in anticipation of Y2K. This further increased the high demand for technology, and the stock market investors were well-aware. It added fuel to the tech-stock fire and caused many to adopt a belief that the best way to make money was in technology stocks.

Covid-19 precautions created a similar tech-heavy narrative to investing in the year 2020. While many of the largest companies profited a great deal from the Covid-lockdown of 2020, investors began to favor any technology companies, even those without profits, by the end of the year.

I decided to go back over the last 20 years to test the idea that the best way to make money is in technology stocks. After all, who could argue that technology companies have not been the most successful since the year 2000? What I found surprised me. From February 2000 to February 2021, the tech-heavy NASDAQ index returned an average of 5.05% per year. How about the more diversified S&P 500? Over the same time, it averaged 5.02%—roughly the same with a lot less volatility.

How could the S&P 500 outperform when “FAANG” (Facebook, Apple, Amazon, Netflix, Google) companies have been so prominent? While these did fine in the early 2000s, the best performing areas were sectors outside of technology.

It is impossible to say exactly what the future will bring, but a change in leadership at some point is inevitable. As we enter the spring of 2021, we may have already seen a change begin. With vaccine distribution, investors have transitioned from a tech-loving lockdown to a stimulus-charged reopening. Only time will tell if this is truly the beginning of new market leadership or if that change won’t come until later.

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Has All This Stimulus Created A Rational Bubble?

By | 2021, Money Moxie, Newsletter | No Comments

One of the most absurd and fascinating financial stories of the pandemic was Hertz. Yes, the Hertz that pre-Covid was the second-largest rental car company. Last April, it had 700,000 vehicles sitting idle and $19 billion in debt! On May 22, 2020, Hertz filed for bankruptcy protection. Then, just a few days later, the stock began a miraculous rise.

Between May 26th and June 8th, Hertz stock rose nearly 1,000%. A savvy investor might think that after all creditors are paid, there may be something left over for stockholders. In reality, Hertz had become one of the first social media stocks of the pandemic.

Individual investors encouraged each other to buy Hertz because it was “going to the moon” and “You Only Live Once,” also known as just YOLO.

Hertz recently announced it might be purchased for just under $5 billion—a number far below the $19 billion in debt. Eventually, investors realized this would happen because the stock could not stay above its June 2020 high. In reality, it is now worth approximately zero.

We have seen the manic rise and fall of many stocks, most of them in January and February of this year and most of them unprofitable. The reasons are complicated, but we will summarize them below:

(1) Gamification of investing with free phone apps
(2) People stuck at home with more free time
(3) Free money from Uncle Sam
(4) Leverage through the use of options
(5) Market makers hedging their risks
(6) Short sellers forced to cover

Let’s focus on the one that impacts all of us as investors: “free money.” The U.S. government has now approved three rounds of stimulus, totaling around $6 trillion. (An additional $4 trillion from the Federal Reserve went into financial markets over the last year.)

As described in the graphic below, the majority of Americans are not planning to spend the stimulus immediately. It has led Americans to save more money in the past year than any other time recorded in U.S. history!

Combine all these savings with reduced household debt, and we get a very flexible consumer. Remember, consumer spending is 69% of the U.S. economy.

Much of these savings will eventually get spent or find their way into investments, which is why some have called the rise in the stock market a “Rational Bubble.”

The health situation has drastically improved since January. While the United States continues to face even more contagious variants of Covid-19, vaccine distribution has substantially expanded. As of March 15th, over 90 million doses had been administered. Plus, approximately 2 million more Americans receive a dose each day.

Nationally, the best-case scenario may be happening. High economic growth (likely to top 6% this year) and low inflation (rising to possibly 3%) make it easier to handle the heavy level of debt. Many states, from New York to California, are easing restrictions. Other, less densely populated states are already way ahead in reopening.

In Utah, the governor thought we would have a massive deficit when shutdowns began last spring. Instead, the state ended up with a $1.5 billion surplus, and in February 2021, Utah had an unemployment rate of just 3.1%.

A year ago, many debated what the financial recovery would look like. Would we have a sharp rebound or a V-shaped bounce, or would it be a slower U-shaped or volatile W-shaped recovery?

The reality has been a letter not previously used to describe economics, but one that I think we will see again in the future. Our current progress has been called a K-shaped recovery because while it has been good for some, it has been difficult for others. As we emerge in Spring 2021, we hope to see more joyful and prosperous times for all.

*Research by SFS. Data from the Federal Reserve Bank of St. Louis. Investing involves risk, including the potential loss of principal. The S&P 500 index is widely considered to represent the overall U.S. stock market. One cannot invest directly in an index. Diversification does not guarantee positive results. Past performance does not guarantee future results. The opinions and forecasts expressed are those of the author and may not actually come to pass. This information is subject to change at any time, based upon changing conditions. This is not a recommendation to purchase any type of investment.

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What does a Biden presidency mean for the economy and investing?

By | 2021, Executive Message, Money Moxie, Newsletter | No Comments

The recent election has some people elated and others in the depths of despair. While we don’t focus on the political ramifications, we can consider some of the financial impacts that may come. There is no guarantee that any of these will happen, but here are some possibilities:

We get more stimulus: In the short-run, this is a great thing for our economy and the market. There are too many Americans and businesses that are still struggling and need help to get through this pandemic. The long-term challenge is how to pay down the government debt.

Taxes go up: Even before the election, we knew that taxes needed to go up because of the massive amount of government debt. We have been at historically low tax rates. While tax rates seem unlikely to go up soon, don’t plan on them staying this low forever. Depending on your situation, you may want to realize taxation of some assets now to avoid paying taxes in the future. Consult with your financial and/or tax advisor.

Interest rates go up: They will probably still stay low for a while (i.e. 1-2 years). However, they will probably start going up after that. Increasing rates are good for savers and bad for borrowers. CD’s may pay a decent rate in the future, but affording a home will get harder.

Investing in ESG goes up: ESG stands for Environmental, Social, and Governance, also known as sustainable investing. With the Democrats in power, companies that are ESG friendly should get a boost. Examples of companies that will benefit include green energy, health and safety, and companies that promote diversity.

The economy will grow: The economy will probably start to recover quickly at first as we accelerate out of the global pandemic. However, growth will probably be slowed down by taxes and inflation after that, but it will still go in the right direction.

The market may go up: In the long-run, this is certainly likely. Over the coming months, the market could go up because of the recent stimulus and the prospect of more stimulus. A great deal of this money is likely to go directly into investments, while some will boost the economy through spending.

There may be some softness after that. But, as the economy fully recovers from the global pandemic, the market should continue its march higher. The market has shown that it doesn’t matter which political party is in power. It still does what it is going to do.

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The Promise of Prosperity

By | 2016, Money Moxie, Newsletter, Viewpoint | No Comments

Americans want a strong country and growing economy. That much we agree on. Of all the promises we heard this election year, none may be more difficult to keep than the commitment to boost growth up to levels last seen decades ago.

Since 2009, the U.S. economy has increased at a rate of 2 percent. Many countries envy that number, but Americans expect more. Our increases were twice as big 20 years ago.

In all of human history I know of no other time with such miraculous growth as post World War II. We have come to accept boom times as normal.

From 1948 to 1973 the average economic output of an American worker doubled. That productivity trend continued until the early 2000s when it suddenly slowed.

prosperity

Consumers Carried the Economy
The “Great Recession” of 2008-2009 complicated things further by drastically altering Americans’ perception of stability and diminishing their tolerance for government debt.

This led to tighter limits on government spending, which has been a huge drag on economic growth. The federal government has cut spending 4 of the last 5 years. This is good short-term because it reduces debt. The long-term impact is less certain.

How much can our economy grow when the government is cutting spending? Who picks up the slack? Businesses have been hesitant to reinvest large amounts in long-term projects. So the responsibility for economic growth has fallen on the shoulders of the U.S. consumer.

Politicians Turned to Spending
Today, politicians and economists are calling for stimulus. What form this takes is yet to be seen, but the popularity of such an idea is rising. Both presidential candidates announced plans to increase government spending to improve infrastructure and stimulate an atmosphere of growth. Donald Trump plans to increase spending by $500 billion. (Hillary Clinton proposed bumping it up by $275 billion.)

Will Stimulus Work?
The answer for decades following the Great Depression was “yes.” The theory is that for every dollar the government spends it can boost the economy by several dollars—creating more wealth than was spent as the dollars circulate through the country.

It fell out of favor in the 1980s and 1990s. Now it’s back.

If stimulus is going to work then it should be concentrated on “fiscal multipliers.” These are the best places and they are often described as levers that can be pulled to actually create growth in the economy.

For stimulus to work it should be focused on the most effective area: infrastructure. Why?
1. Immediate creation of jobs
2. Jump in demand for construction materials
3. Greater efficiency for the entire economy
4. Investment in the future of America

Our bridges, airports, and freeway systems are in need of repair. Our electric grid is outdated and vulnerable as well. Technological advancements have redefined living. It may be time to apply some innovative American ingenuity to our infrastructure.

If there ever was a time that Americans could benefit from this stimulus it would be following a lack of spending—a situation we now find ourselves in.

 

*Research by SFS. Data from the Federal Reserve Bank of St Louis. Past performance does not guarantee future results.

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The Federal Reserve Will Soon End its Easy Money Stimulus

By | 2013, Money Moxie, Newsletter, Viewpoint | No Comments

When Lehman Brothers collapsed in 2008, all lending essential stopped. The U.S. Federal Reserve (Fed) feared that all five investment banks in this country would cease to exist. No one fully understood the financial calamity coming, but we were beginning to feel what the worst recession in 80 years would be like.

The Fed acted to stop the financial infrastructure from imploding. It believed cushioning the blow was necessary to help all Americans. It started the Troubled Asset Relief Program (TARP). It added to that program over the years with Quantitative Easing (QE) one, two, and three.

Recent years may not have felt like easy money to us, but there is likely no organization more profitable in recent years than the Fed.

The Fed doesn’t literally print money (a responsibility of the U.S. Treasury). It doesn’t have to. Money is created electronically by the Fed and infused into the financial system through open market actions. Its effectiveness is questionable. Its impact is global. And at some time soon it may be ending.

What Is the Fed’s Impact?

Currently, the Fed is spending roughly $85 billion each month to buy treasury bonds in order to keep long term interest rates at historically low levels. The goal is to encourage risk taking. The Fed wants banks to lend, businesses to hire, and consumers to borrow.

If you have purchased a home, refinanced a loan, or bought a car with debt, then you have benefited from these unprecedented efforts of the Fed.

All this money the Fed is creating seems to be working to a small degree. The U.S. stock market* is on track for its fourth positive year in the last five. If you have invested in stocks or bonds consistently during this time, you have probably benefited from the Fed’s actions. Experts have been debating how well the Fed’s historic efforts have worked. One theory is that each time the Fed spends, it has less positive impact than the previous effort. This would explain the lackluster growth in the economy.

Why Is the Fed Still Involved?

Simply stated, the benefits still appear to outweigh the risks.

Low interest rates are meant to be enablers for businesses and consumers to increase borrowing. If the debt gets out of hand, then we will be facing similar problems to those that got us into this mess.

If spending and demand increase too much, then inflation could rise to levels considered too high for a developed economy (greater than 4 percent). At that point, the Fed will have to react to try to slow down the economy even if it means job losses.

At this point, official inflation is tame and private debt levels do not appear inflated like in 2007.

As long as the risks appear low and unemployment is above 7 percent, the Fed is likely to keep spending.

What Will Happen When the Fed Slows Stimulus?

Interest rates will rise from the unusual levels where they currently are to a more natural rate determined by investors. We experienced a taste of what this will feel like this spring and summer. Rates on the 10 year treasury almost doubled in just a few months. Investors saw an increase in volatility.

Where Is the Silver Lining?

Don’t fight the Fed is a common phrase for investors. The Fed is powerful and it is working for what it believes is best for Americans. It plans to cut stimulus only after it determines that the U.S. economy is strong. If rates rise that should bring better yields for savers.

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